Advanced Underwriting Consultants

Question of the Day – August 21

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question:  My married clients put together an irrevocable trust (ILIT) to own survivorship life insurance a few years ago.  May the same trust own insurance that covers just one of their lives?

Answer:  Probably yes, so long as the surviving spouse does not need access to the life insurance death benefit.

An attorney drafting an irrevocable trust designed to own survivorship insurance will generally include language that the trust is for the sole benefit of the insureds’ children.  That is because if either insured under the survivorship policy is a beneficiary of the ILIT, then the policy’s death benefit may be included in the beneficiary-spouse’s taxable estate.  Most couples who go to the trouble of drafting an ILIT would want to avoid estate tax inclusion of the policy’s death benefit.

An attorney drafting a policy designed to own a single-life policy may draft the ILIT differently.  Many such trusts give the non-insured spouse a limited ability to make claim on the death benefit if needed for health, maintenance and support.  A properly drafted ILIT of this type will keep the death benefit from being included in the taxable estate of either spouse.

A single-life policy can usually go into an ILIT drafted for survivorship insurance, because the lack of access by surviving spouse does not cause an estate tax problem.  However, the surviving spouse would generally not have access to the policy’s cash values or death benefit.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day. 

Question of the Day – November 14

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Here’s the Question of the Day

Question: Is there a compelling reason for the owner of a closely held business to use money from the business to pay for life insurance needed to pay estate taxes?

Answer: Maybe.

There are usually few, if any, income tax reasons to have the 100% owner of a closely held business use business money to pay for needed life insurance.  However, there may be compelling gift tax reasons to do so.

When life insurance is used to pay for estate taxes, the coverage is usually owned by an irrevocable trust (ILIT), or, in the alternative, adult children.  If the insured transfers money to the ILIT or adult children by gift, the insured must deal with the gift tax limitations imposed by the federal and relevant state governments.

If the insured is worried about gift tax limits, it may be possible to access money from the business in different ways to provide the money needed for the premium:

1. A split dollar plan between the business and the ILIT may lower the gift tax cost of the premium.

2. If the adult children are employees of the business, the business may pay them extra to cover the premiums associated with the life insurance policy.

3. The business may be able to lend money to the ILIT or adult children to provide the premium needed for the coverage.

Each of these alternatives may lower or eliminate the gift tax cost associated with the insurance meant to pay the insured’s estate taxes.  However, each alternative has its drawbacks.  Talk with the proposed insured’s estate planning attorney and accountant to decide whether one of these might be the right choice.

Question of the Day – October 26

Ask the Experts!

Here’s the question of the day.

Question: My client wants to wait to draft his irrevocable trust until after he’s sure he wants to buy the life insurance.  How can I make that work?

Answer: Life insurance death proceeds are includible in the taxable estate of the insured if the insured owns the policy.  If the insured transfers a policy on his life by gift, and dies within three years of the transfer, the death benefit is also included in the insured’s taxable estate.

To avoid having life insurance be included in the insured’s taxable estate, we usually recommend having an irrevocable life insurance trust (ILIT) own the policy from inception.

In a perfect world, ILITs are implemented this way:

  1. The ILIT is created and funded by the grantor.
  2. The trustee of the ILIT sends withdrawal notices to the beneficiaries.
  3. The beneficiaries decide not to withdraw the money.
  4. The trustee decides to apply for insurance on the life of the grantor.
  5. The insurance is approved.
  6. The trustee pays the premium.

The reason for these theoretical steps is to conform to the requirements of the court cases and ILIT rules and regulations.

The procedure described is NOT the only way to achieve estate tax exclusion of the death benefit.  However, some variations from the perfect implementation may create a danger of inclusion in the grantor’s estate for three years after the purchase of the insurance.

According to IRS Technical Advice Memorandum (TAM) 9323002, an application can be submitted to the insurance company without any kind of premium deposit, and so long as the trust is executed by the completion of the underwriting, a new application can be filed with the insurance company.  If the policy is issued with the trust as the owner—and the first actual premium payment is made by the trustee as the owner—then the IRS said there’s no policy transfer.  No transfer means no three year estate tax inclusion.

A prospective insured following the TAM procedure might sign an application, get approved for the coverage, get his lawyer to draft an ILIT in a hurry, and have the agent ask the insurance company to list the trust as owner and beneficiary prior to the policy being put in force.

Of course, the TAM is not authority that any particular taxpayer can rely on, but it is a reflection of how the IRS generally looks at these issues.  The best advice is to let the client’s attorney make the call on whether the attorney is comfortable with the procedure described.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.