Last week the Tax Court, in a case of first impression, ruled that payments made by a decedent through a trust to pay premiums on life insurance policies obtained to fund buy-sell agreements should not be regarded as loans still owed to her estate.
The case, Estate of Morrissette v. Commissioner, 146 T.C. No. 11, is groundbreaking for the tax, wealth planning, and insurance communities because the court‘s decision opens the door to intergenerational split-dollar arrangements, thereby easing the passage of family assets such as closely held businesses through the generations with predictable estate and gift tax consequences to the original owners.
“People have used split-dollar arrangements as a way to fund the purchase of life insurance for fifty years,” said Jim McNair, an attorney with Reed Smith who, along with Reed Smith attorneys Eric Wang and Kelly Miller, argued the case for the Estate of Clara Morrissette.
“In a typical case, I start up my company, the company makes money, I’m worried about having to pay estate tax on my stock in the company, so I set up a trust and the company advances money to the trust,” he said. “The trust would buy insurance on my life and then the company would have a split dollar receivable—kind of like a loan, but governed by a different set of rules. When I pass away the trust would collect the death benefit and repay the company.”
So in the typical case, the receivable gets paid back to the company at the same time or shortly after the death of the decedent, he explained.
“What’s different here is that Mrs. Morrissette advanced the money to pay the premiums to the trusts, and the trusts employed those funds to purchase the insurance policies. She was in her 90s and her sons were in their 60s and 70s and about to retire. Her grandsons were running the company,” he said. “The split dollar receivable was not payable until the death of one of Mrs. Morrissette’s sons. The split dollar receivable here became an asset of her estate, but given her sons’ life expectancy, it was an asset that was not likely to be payable to the estate for at least 20 years. The question was how to value the asset.”
When she died in 2009, the estate valued the policies at approximately $7.5 million. The IRS determined that the contribution was a gift for tax year 2006, and determined that Mrs. Morrissette had failed to report and pay gift tax on the $29.9 million.
“When the IRS drafted the regulations to govern split dollar arrangements, they created two different ways to treat receivables,” McNair explained. “One way is the loan regime; the other way is the economic benefit regime.”
The Tax Court held that because the only economic benefit conferred upon the trusts was current life insurance protection, the economic benefit regime, not the loan regime, applies. Therefore, the estate was not liable for a 2006 gift tax deficiency determined by the IRS. The net present value of the receivable for estate tax purposes was approximately $7.5 million, a $22.5 million discount on the $30 million advance originally made by Mrs. Morrissette.
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