Analysis of and reflections on recent cases and rulings.

• Author: Beavers, James A.
• Position: TAX TRENDS

Estates, Trusts & Gifts

Tax Court determines value of receivable from a split-dollar life insurance arrangement

The Tax Court held that the value includible in a taxpayer's gross estate for a receivable created under split-dollar life insurance arrangements was the stipulated value of the receivable, not the much higher cash-surrender value of the insurance policies purchased under the arrangements.

Background

Marion Levine, throughout her life, had been a successful entrepreneur and businessperson. She and her husband bought a single grocery store in 1950 and over the years built it into a 27-store chain. After her husband died, she took over the business and sold it in 1981 for $5 million. She took the proceeds from the sale and successfully reinvested the money into other businesses that she actively participated in, increasing her net worth to $25 million.

In 1988 she took a first step in estate planning, creating a revocable trust with herself as trustee. Her son, Robert, her daughter, Nancy, and her longtime accountant and business adviser, Bob Larson, were successor trustees of the trust, and Robert, Nancy, and their children were the trust's beneficiaries.

In 2008, Levine entered into split-dollar life insurance arrangements (split-dollar arrangements) that required her revocable trust to pay premiums for life insurance policies taken out on the lives of Nancy and Nancy's husband, Larry. Pursuant to the arrangements, when they terminated, Levine's revocable trust had the right to be paid the greater of the premiums it paid or the cash-surrender value of the policies (the split-dollar receivable). An irrevocable life insurance trust (the insurance trust) was set up to be the owner of these policies.

Levine's children and grandchildren were the beneficiaries of the insurance trust, and Larson was the sole member of the investment committee that managed the trust. Larson, Robert, and Nancy also acted as Levine's attorneys-in-fact and as the revocable trust's successor co-trustees (and, after 2005, its co-trustees). As the sole member of the irrevocable trust's investment committee, only Larson had the right to prematurely terminate the life insurance policies: The arrangements gave Levine, Robert, and Nancy no rights to terminate the policies or the arrangements themselves. In 2009, shortly after the split-dollar arrangements were fully set up, Levine died.

Recognizing that Levine, through her revocable trust, had made gifts to the insurance trust and its beneficiaries, the attorneys-in-fact filed gift tax returns on Forms 709, United States Gift (and Generation-Skipping Transfer) Tax Return, for 2008 and 2009. Each return reported the value of the gift as the economic benefit transferred from the revocable trust to the insurance trust. Based on the rules in Regs. Sec. 1.61-22(d)(2), the value of the gift reported on the returns was $2,644.

The attorneys-in-fact also realized that the promise by the insurance trust to pay the revocable trust had some value at Levine's death in 2009, which had to be reported on Levine's estate tax return. On Schedule G, Transfers During Decedent's Life, of Levine's Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, the value of the split-dollar receivable, as owned by the revocable trust on the alternate valuation date, was reported as an asset worth about $2 million. The IRS and Levine's estate later stipulated that the value of the split-dollar receivable was $2,282,195.

The IRS audited Levine's gift tax returns and her estate tax return. It issued a notice of deficiency for the 2008 gift tax return and a notice of deficiency of slightly more than $3 million for the estate tax return. Levine's estate challenged both notices of deficiency in Tax Court in separate cases, which the court consolidated. However, the IRS lost on the gift tax issue, with the court in 2016 holding, based on its opinion in Morrissette, 146 T.C. 171 (2016) (Morrissette I), that it was obligated to enter judgment against the IRS (Estate of Levine, No. 9345-15 (T.C. 7/13/16) (bench op.)). That issue being disposed of, the court severed the gift and estate tax cases, leaving the estate's challenge of the IRS's determination regarding the estate tax to go forward.

The IRS argued in Tax Court that Levine's estate should have reported the cash-surrender values of the life insurance policies, not the value of the receivable, on the estate tax return. The Service reasoned that:

* Under Sec. 2036, Levine retained the right to income--or the right to designate who would possess the income--from the split-dollar arrangements and under Sec. 2038, she maintained the power to alter, amend, revoke, or terminate the enjoyment of aspects of the split-dollar arrangements; and

* Even if the full values of the life insurance policies are not includible in Levine's estate under Secs. 2036 or 2038, the restrictions in the split-dollar arrangements should be disregarded under the special valuation rules provided in Sec. 2703, which would force Levine's estate to include in its taxable value the full cash-surrender values of the policies.

The estate argued that it made no transfer of property that could trigger Sec. 2036 or 2038, it retained no interest in the property that it did transfer, and, in any event, the bona fide sale for adequate and full consideration exemption applied.

After the parties settled other issues in the case through stipulation, the Tax Court was left to decide whether the value of the split-dollar receivable held by Levine's estate was $2,282,195...