Estate Not Liable for Additional Taxes in Split-Dollar Insurance Arrangement.

(Parker Tax Publishing APRIL 2016)

The lump-sum payment of premiums made on split-dollar life insurance policies by a decedent's trust did not generate any additional economic benefit other than current life insurance protection to Dynasty Trusts set up by the decedent for her three sons. Thus, the decedent's trust was the deemed owner of the policies and the split-dollar life insurance arrangements were governed by the economic benefit regime and the decedent's estate did not owe additional taxes. Est. of Morrissette, 146 T.C. No. 11 (2016).

Clara Morrissette's late husband started a moving company called Ace Van & Storage in Washington, D.C. From 1954 until 2002, the Morrissette family incorporated or purchased a total of 10 companies in addition to Ace Van & Storage (referred to as the Interstate Group). In 1994, Morrissette established a revocable trust, the Clara M. Morrissette Trust (CMM Trust). She appointed herself as the initial trustee, and contributed all of her stock in each company in the Interstate Group to the CMM Trust. In September 2006, Morrissette's three sons - Arthur, Donald, and Kenneth - became successor co-trustees of the CMM Trust. In 2006, Morrissette established three perpetual trusts for each of her sons and their families (collectively, the Dynasty Trusts).

In September of 2006, the Dynasty Trusts, the Morrissette brothers, the CMM Trust, and all other trusts holding an interest in the Interstate Group entered into a shareholders agreement. The agreement provided that upon the death of Arthur, Donald, or Kenneth, his surviving siblings and their respective Dynasty Trusts would purchase the Interstate Group stock held by, or for the benefit of, the deceased sibling (i.e., the buy-sell provisions). The CMM Trust was subsequently amended in 2006 to permit the trustee to (1) pay premiums on life insurance policies acquired to fund the buy-sell provisions of the business succession plan, and (2) make loans, enter into split-dollar life insurance agreements or make other arrangements. Additionally, the amendment authorized the trustee to transfer each receivable from the split-dollar life insurance arrangement when paid by each Dynasty Trust back to the Dynasty Trust owing the receivable or directly back to each son.

To provide the Dynasty Trusts with the resources to purchase the stock held by or on behalf of a decedent, each Dynasty Trust purchased two universal life insurance policies, one on the life of each other brother. To fund the purchase of the policies, each Dynasty Trust and the CMM Trust entered into two split-dollar life insurance arrangements. The CMM Trust contributed $29.9 million to the three trusts to be used to pay a lump-sum premium on each policy to maintain that policy for the insured's projected life expectancy.

From 2006 to 2009, Morrissette reported gifts to the Dynasty Trusts as determined using the economic benefit regime set forth under Reg. Sec. 1.61-22. The amount of each gift reported was the cost of the current life insurance protection as determined using Table 2001 issued by the IRS, less the amount of each premium paid by the respective Dynasty Trust. Morrissette reported gifts to approximately $637,000 in years 2006 through 2009. After Morrissette died, the estate retained a valuation company to value the receivables includible in the gross estate as of the date of her death. The valuation company issued its opinion regarding the value of the receivables as of the date of death and the estate relied on the appraisal to report approximately $7.5 million of receivables on the estate tax return.

In 2013, the IRS issued two notices of deficiency to the estate - one for gift tax liability for 2006 of $13.8 million and one for a Code Sec. 6662 penalty of almost $2.8 million. According to the IRS, the estate had failed to report total gifts of $29.9 million, the total amount of the policy premiums paid for the six split-dollar life insurance policies in 2006. Before the Tax Court, the IRS argued that Notice 2002-59 applied and prohibited the use of the economic benefit regime. Further, the IRS argued, the "prepaid premiums" paid not only for current insurance protection, but also for future protection, which was a benefit other than current life insurance protection and required that the arrangement be taxed under the loan regime. This position also relied on Notice 2002-59 for the proposition that prepayment of future premiums (by paying a single premium) confers policy benefits other than current life insurance protection.

Reg. Sec. 1.61-22 provides two mutually exclusive regimes for taxing split-dollar life insurance arrangements:

(1) the economic benefit regime, or

(2) the loan regime.

The determination of which regime applies to a split-dollar life insurance arrangement depends on which party owns, or is deemed to own, the life insurance policy subject to the arrangement. Generally, the person named as the owner in the insurance contract is treated as the owner of the contract. A nonowner is any person other than the owner who has any direct or indirect interest in the contract. Under this general rule, the Dynasty Trusts would be considered the owners of the policies and the loan regime would apply. However, as an exception to the general rule, Reg. Sec. 1.61-22(c) includes a special ownership rule that provides that if the only economic benefit provided under the split-dollar life insurance arrangement to the donee is current life insurance protection, then the donor is the deemed owner of the life insurance contract, irrespective of actual policy ownership, and the economic benefit regime will apply. If, on the other hand, the donee receives any additional economic benefit, other than current life insurance protection, then the donee will be considered the owner and the loan regime will apply.

The key question before the Tax Court was whether the lump-sum payment of premiums made on the policies indirectly by the CMM Trust generated any additional economic benefit other than current life insurance protection to the Dynasty Trusts. If no additional economic benefit to the Dynasty Trusts was generated, then the CMM Trust is the deemed owner of the policies as a result of the special ownership rule and the split-dollar life insurance arrangements would be governed by the economic benefit regime. If any additional economic benefit is conferred, then the Dynasty Trusts own the policies and the loan regime would apply.

The Tax Court sided with the estate and held that, because the Dynasty Trusts received no additional economic benefit beyond that of current life insurance protection, the CMM Trust was the deemed owner of the life insurance contract by way of the special ownership rule under Reg. Sec. 1.61-22. Thus, the economic benefit regime applied.

In reaching its holding, the Tax Court noted that the preamble to Reg. Sec. 1.61-22 included an example structured identically to the split-dollar life insurance arrangements at issue and the preamble was consistent with the estate's interpretation of the statute and contrary to the IRS's position. While the court noted that it has previously been unpersuaded by a preamble, it found the logic of the preamble sound in this case. With respect to the IRS's reliance on Notice 2002-59, the court said that the split-dollar life insurance arrangements in the instant case bore no resemblance to the transactions in Notice 2002-59.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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