Advanced Underwriting Consultants

Question of the Day – June 13

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Here’s the question of the day.

Question:  My client owns a MEC life insurance policy that she wants to exchange for an immediate annuity.  What are the tax consequences of doing so?

Answer:  The exchange of a life contract for an annuity is tax-free under Code Section 1035.  That’s true whether it’s a “regular” life contract being traded for an annuity or a MEC that’s being traded.

If a MEC is traded for a SPIA, there’s no tax recognition at the time of transfer.  Each of the SPIA payments will each be partly a recovery of basis (based on the basis from the MEC life policy) and partly ordinary income.

The ordinary income portion of the payments will also be subject to the 10% penalty tax if the taxpayer is younger than 59 ½ and if the SPIA payout period is for a duration shorter than the taxpayer’s life expectancy.

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 – June 27

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Here’s the question of the day.

Question: What are the tax consequences of making a large gift to a family member?

Answer: A gift of cash to a family member is not generally subject to extra income taxes for either the donor or the done.  Neither is the gift income tax deductible.

Large gifts may be subject to federal or state gift taxes.  The federal government allows a donor to make gifts of up to $13,000 in a calendar year to each prospective done without any gift tax consequences.  These types of gifts are referred to as annual exclusion gifts.

If a donor wants to make gifts in excess of annual exclusion gifts, the donor can choose to use some or all of his or her lifetime exemption.  A taxpayer in 2012 has a $5.12 million lifetime exemption.  The taxpayer uses the lifetime exemption to shelter gifts that would otherwise be subject to gift taxes from those taxes.  Any part of the exemption used to shelter gifts during lifetime reduces the amount of the exemption available against federal estate taxes at death.

Gifts in excess of the lifetime exemption amount are subject to federal gift taxes at a rate of 35%.

Until recently, Connecticut and Tennessee were the only two states that imposed a gift tax on large gifts made by residents.  However, Tennessee recently repealed its state gift tax.

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 – April 23

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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 80 year old client has put her 50 year old son on as a joint tenant with right of survivorship (JTWROS) on her brokerage account.  What are the gift tax and income tax consequences of that transaction?

Answer: There probably aren’t any results right now.

The income and gift tax consequences related to a nonqualified brokerage account owned jointly depends on who put the money in.  In general, if the parties are not married, the ownership of the account for tax purposes stays with the donor.  In the situation described above, Mom put in all the money.  Mom still is considered to be the owner the account from an income and gift tax perspective.

If the current brokerage custodian accepts just one signature for withdrawals, Mom should be able to get the money out without gift tax or administrative issues.  If part of the account needs to be liquidated, Mom will recognize an income tax result when the underlying securities are sold.

On the other hand, if Son gets a cash distribution from the account, that will be considered to be a gift taxable distribution from Mom to Son.

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 – December 19

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Here’s the question of the day.

Question: My client wants to make a gift of an income stream to his grandchild.  The client intends to make a $50,000 deposit into a five year certain SPIA, and assign the income stream to the grandchild.  The SPIA payments are about $12,000 per year.  What are the gift tax consequences of the plan?

Answer: Clearly, the client is making a taxable gift to the grandchild.  The only issue is whether it’s a gift of $50,000 in year one, or annual gifts of $12,000 in years one through five

If the client assigns all rights to the SPIA to the beneficiary at the beginning of the SPIA term, the present value of the income stream–$50,000—will be treated as a taxable gift in year one.  Since the gift would be in excess of the annual exclusion amount ($13,000 in 2011 and 2012), the client would need to fill out a federal gift tax return.

If the client instead kept the right to the SPIA payments himself, but after receiving them turned them over to the grandchild, the client would be making annual gifts of $12,000 each year to the grandchild.  If the client made no other gifts to the grandchild, the gifts would qualify for the annual gift tax exclusion.  No gift tax return would be required.

If the client follows the second path, the client will get the income tax result associated with the immediate annuity payments.  If the first path is followed, it’s the grandchild who recognizes taxable income on the annuity payments.

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 – October 18

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Here’s the question of the day.

Question: What are the tax consequences of making a gift of a life insurance policy subject to a loan?

Answer:   The gift of a policy in which the outstanding loan exceeds the owner’s basis may create an income tax liability not only to the donor upon transfer of the policy, but also to the donee upon the death of the insured.

The reason for this disastrous turn of events is the transfer of a policy with a loan exceeding basis is treated not as a gift, but as part-gift, part-sale.  The consideration, or sale price, is the donee’s assumption of the outstanding loan.  Code Section 1001(b) states amount received from a sale consists of the sum of cash plus the fair market value of property received other than cash.  Regulation 1.1001-2(a) says that amount received includes “the amount of liabilities from which the transferor is discharged as a result of the sale or other transfer.”

Let’s assume the owner of the $1 million death benefit policy in the following example decides to gift it to a child or an irrevocable trust.

Cash surrender value $  8,353.00
Total loans $66,466.00
Basis ( $ 3,802 premium x 10 years ) $ 38,020.00

The cash value, $8,353, is considered to be a gift.  An amount equal to the outstanding loan is considered to be a sale.  Thus, the owner receives $66,466 (assumption of the outstanding loan by the new owner) for property with a basis of $38,020.  The owner must report ordinary income of $28,446 on the transaction.

Furthermore, the donee will be taxed at the insured’s death.  Code Section 101 provides any transfer for a valuable consideration of a right to receive all or part of the proceeds of a life insurance policy is a transfer for value.  The donee’s assumption of the policy loan is considered to be valuable consideration.

Where a life policy is transferred for value, the amount of its death proceeds excludable from income is limited to consideration paid for the policy by the transferee plus any further premiums.  Unless the transaction falls under one of the exceptions to the transfer for value rule, the donee will owe income tax on the death benefit to the extent it exceeds her basis in the policy.

The donee’s basis in the policy is determined according to the rules set out in Regulation 1.1015.  In a part sale, part gift transaction, the donee’s unadjusted basis in the transferred property is equal to the gift tax paid by the donor plus the greater of (1) the consideration paid or deemed to have been paid by the donee, or (2) the donor’s adjusted basis in the property.

In our example, the donor paid no gift tax, therefore the donee’s unadjusted basis in the policy is $66,466 (the greater of $66,466 or $38,020).  Suppose the donee continues the policy and pays $50,000 in premiums prior to the insured’s death.  To the extent the donee receives death proceeds exceeding $116,466 ($66,466 plus $50,000), she must pay income tax on the excess.  In this example, that means $883,534 of the death benefit that’s taxable.

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.