Estate tax is a crucial aspect of financial planning that individuals and families need to consider. One strategy that has gained popularity in recent years is the use of split-dollar life insurance arrangements in estate planning. These arrangements involve a third party paying insurance premiums on behalf of an insured person while maintaining the right to reimbursement of some or all of the premiums. While split-dollar contracts have traditionally been used in employer-employee relationships, they are now being utilized in various settings, including estate planning.
The U.S. Tax Court has recently been called upon to address the estate tax implications of split-dollar contracts in three notable cases: Estate of Cahill, Estate of Morrissette, and Estate of Levine. These cases all involved split-dollar contracts and were challenged by the IRS under sections 2036 and 2038 of the Internal Revenue Code, which require the inclusion of transferred property in a decedent’s gross estate under certain circumstances.
Sections 2036 and 2038 of the Internal Revenue Code are designed to prevent taxpayers from avoiding estate and gift taxes by transferring assets without adequate consideration. These provisions apply when a decedent makes an inter vivos transfer of property without receiving full and adequate consideration in return. Section 2036 applies if the decedent retains possession or enjoyment of the property at the time of death, while section 2038 applies if the decedent retains the right to alter or revoke the transferred property.
In the Estate of Cahill case, the taxpayer entered into a split-dollar arrangement at the age of 90, where the revocable trust paid $10 million in premiums on life insurance policies. The Tax Court ruled that sections 2036 and 2038 applied because the decedent had the right to terminate the split-dollar contract in conjunction with another party.
In the Estate of Morrissette case, the taxpayer and her husband used split-dollar life insurance to provide liquidity for estate taxes. The Tax Court ultimately ruled that sections 2036 and 2038 did not apply due to a legitimate nontax purpose for the arrangement and adequate consideration received by the decedent.
In the Estate of Levine case, the taxpayer’s split-dollar arrangement differed in that the revocable trust did not have the right to terminate the contract. The Tax Court found that sections 2036 and 2038 did not apply in this case, as the termination rights were held by a third-party individual with fiduciary obligations.
These cases highlight the complexities of split-dollar life insurance arrangements in estate planning and the importance of careful consideration when utilizing these strategies. Tax professionals should closely monitor developments in this area to ensure compliance with tax laws and regulations when advising clients on estate planning matters.