Retroactive medicine for transfer for value problems with life insurance.

• Author: McKoy, Lawrence W.

As a general rule, proceeds from a life insurance policy received by a beneficiary are excluded from gross income under Sec. 101(a). One exception to this general rule is the "transfer-for-value" rule of Sec. 101(a)(2). Sometimes Sec. 101(a)(2) is found to apply to an existing life insurance policy, causing a disallowance of the exclusion. Often this situation resuits when a life insurance policy is transferred several times. When a transfer is made for valuable consideration and subject to the transfer-for-value rule, creative use of the statutory exception can avoid loss of the exemption.

The key to planning is that the rules look at the final transfer in a series of xs and work backwards. Thus, a transfer that qualifies as an exception under Sec. 101{a}(2)(A} and (B} will remove the "transfer-for-value" taint from a prior transfer. This opens up possibilities for recycling insurance policies through exempt transfers, thus avoiding the transfer-for-value rule.

In IRS Letter Ruling 8906034, a series of transfers was used to remove corporate-owned life insurance from the corporation to an owner/father who in turn transferred the policy by gift to his son. The son was to use the policy proceeds to buy the stock of the corporation from the estate. A direct transfer from the corporation to the son would have been tainted as a transfer for value. However, the transfer to the father qualified as a transfer to the "insured" {one of the exceptions under Sec. 101(a)(2)(B)) and the gift to the son qualified as a transfer in which "basis in hands of the transferee is determined by basis of transferer, (another exception under Sec. 101(a)(2)(A)).

In IRS Letter Ruling 8951056, a father purchased life insurance subject to policy loans from an irrevocable insurance trust that included his wife as trustee and beneficiary. He then contributed the same...