More On Tax Planningfrom The Advisor's Professional Library
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- Annuities: Estate Tax The value of certain types of annuities may be included in an estate’s value. Understanding the intricacies of these inclusions is a critically important aspect of estate planning.
You give your clients clear instructions about handling their life insurance trusts, but what happens when they disregard your instructions and get themselves into an intractable tax mess by personally paying premiums directly to the carrier? Direct payment of premiums on a policy in an ILIT can net your clients a big gift tax bill. Is there anything you can do to soften the blow and get them back on track?
The Tax Court recently considered a case, Estate of Turner v. Commissioner, where an insured did just that—paying some premiums directly to the carrier against orders—and correctly gifting some premiums to the trust. Turner’s estate believed that the premium payments made directly to the carrier were present interest gifts qualifying for the $10,000 annual gift tax exclusion ($13,000 in 2011). The IRS disagreed, claiming that the direct payments were gifts of future interest that were subject to the gift tax and ineligible for exclusion.
Present Interest Gifts
A donor can make $13,000 in gifts (2011) to a person each year without gift tax exposure. The catch is that this annual exclusion can’t be used to exclude gifts of future interests from gift tax; a gift must be of a present interest to be excludable. As a result, no gift of a future interest can be excluded from gift taxation using the annual exclusion.
A present interest is “an unrestricted right to the immediate use, possession, or enjoyment of property or the income from property (such as a life estate or term certain).” A gift is not a present interest gift if it is subject to a third party’s discretion. Thus, if a gift is made in trust and use of the gift by the recipient is solely in the discretion of a trustee, the gift will not qualify for the annual exclusion.
The job of ensuring present interest treatment of premium payment gifts to life insurance trusts has typically fallen on the Crummey letter. The landmark Crummey decision spawned Crummey planning, under which most life insurance trust beneficiaries are aware they have a time-limited right to demand withdrawal of the trust additions. Because beneficiaries have a right to demand withdrawals, their interest in gifts to the trust can be classified as a present interest that is eligible for the annual exclusion.
The Court’s Analysis
In Turner, The IRS and the estate agreed that Turner made indirect gifts to the beneficiaries of the trust when he made direct payment of the life insurance premiums on the policy owned by the trust. Where they disagreed is on whether the gifts were of a present or future interest.
The estate claimed that the gifts were present interest gifts because the beneficiaries had an “absolute right and power to demand withdrawals of amounts transferred to [the trust].” The IRS disagreed, claiming that the beneficiaries had only a future interest in the gifts. In their view, because Turner did not make deposits into the trust, paying the premiums directly to the carrier, the beneficiaries had no way to access the gifts. As a result, they had no meaningful withdrawal right.
The court agreed with the estate, holding that, because the beneficiaries had an absolute right to demand withdrawals after each
And it didn’t matter to the court that some of the trust’s beneficiaries might not have understood that they had a right to make withdrawals from the trust following each new gift. According to the court, their absolute right to demand the withdrawals was sufficient for the gift to be classified a present interest gift.
The moral of Turner is not that we can dispose of Crummey letters or that our clients can avoid the inconvenience of making gifts to their ILIT by directly paying life insurance premiums; the IRS has not yet acquiesced to the Turner decision.
So, despite the positive result for the taxpayer in the case, proper Crummey gifting is still an essential aspect of life insurance trust administration. Unless insureds are prepared for the expense of litigation, premiums should still be paid through the ILIT and Crummey letters should still be sent to beneficiaries.
The good news from Turner is that if your clients have been disregarding your instructions and have been paying life insurance premiums directly to the carrier, or if Crummey letters have not been issued diligently, they may be getting a kind of second chance.
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See also The Law Professor's blog at AdvisorFYI.