While the federal estate tax is repealed so far for 2010, there are still estate tax issues that are important to keep up on. As it stands now, the estate tax is scheduled to return in 2011. Also, Congress may institute an estate tax for 2010, either retroactively to January 1, 2010 or on a prospective basis.
Late last year, the Internal Revenue Service issued three nearly identical private letter rulings (200947006, 200948001, and 200949004) which each held that life insurance proceeds on a contract owned by a limited partnership will not be included in the insured person’s estate. The rulings were also significant because the partnership in the rulings held no assets other than the life insurance. Some commentators had believed that a partnership with no assets other than life insurance would not provide taxpayers with favorable tax benefits.
Weighing the Facts
Under the facts of the ruling, a limited partnership had a corporation as its general partner and another corporation and the insured as its limited partners. The insured was the 100% owner of the first corporation. The limited partnership owns a policy on the life of the insured. The policy beneficiaries are the limited partnership and three other related partnerships.
The insured contributed funds to the limited partnership to enable it to purchase the life insurance policy. Two trusts were also were also set up and administered by different members of the insured’s family.
The taxpayer proposed to undertake a series of transactions. The four partnerships will be removed as beneficiaries of the life policy and designate the taxpayer’s children as the beneficiaries. The corporations and the taxpayer will make capital contributions to the first limited partnership in an amount sufficient to allow the limited partnership to make distributions to the taxpayer. These distributions will equal the contributions the taxpayer made to the limited partnership to make past premium payments.
One of the trusts will purchase the taxpayer’s limited partnership interest in the limited partnership and will purchase the taxpayer’s shares of the first corporation. The second corporation will also distribute its limited partnership interest to this first trust.
The second trust will contribute a second life policy to the limited partnership for a limited partnership interest in the limited partnership. The first trust will contribute enough cash to the limited partnership to pay the premiums on the two policies for the remainder of the taxpayer’s life. The taxpayer will then release to the taxpayer’s sister any power to make significant decisions with regard to the first life policy.
After this release, the taxpayer will not have the power to change the beneficiary of the policy, surrender or cancel the policy, assign the policy, revoke an assignment of the policy, pledge the policy for a loan, or to take a loan against the cash surrender value of the policy. Only the assets of the limited partnership will be used to pay the premiums on the life policies. Finally, the limited partnership will designate itself as the sole beneficiary of the life policy.
As a result of these transactions, the two trusts will own 100% of the limited partnership, which in turn will own two life insurance policies, with the beneficiary of each policy the partnership.
The IRS explained that an insured is considered to have an incident of ownership if the individual, either alone, or in conjunction with another person, can change the beneficial ownership of the policy or its proceeds or the time and manner of enjoyment of the proceeds, even though the decedent has no beneficial interest in the trust.
Also, an insured is not considered to have incidents of ownership of a policy held by a business in which the insured has a controlling stake, to the extent the proceeds are payable to the business. Any part of the death proceeds that are not payable to the corporation are not taken into account in valuing the decedent’s stock holdings for estate tax purposes.
But incidents of ownership held by a business as to that part of the proceeds will be attributed to the decedent through the stock ownership where the decedent is the sole or controlling shareholder.
Besides the fact that the IRS ruled that the insured did not have any incidents of ownership in the policy, these rulings are also important because some practitioners and commentators had come to believe that a partnership might not enjoy favorable tax treatment if there was no business purpose for the partnership.
Previous rulings and court cases had discussed partnerships that held policies for business purposes. The partnership in these rulings however, did not have any assets other than the life insurance policies. This would seem to suggest that a business purpose for a partnership’s ownership of a policy is not necessarily needed.
It should also be noted that the IRS did not comment on the possibility that the life policies may have been subject to the transfer for value rule. As part of the series of transactions, one of the trusts contributed a policy to the partnership in exchange for a partnership interest.
This might be viewed as a transfer for value, but would more likely be considered a transaction where gain or loss would not be recognized and on which the transferee (the partnership) would take the transferor’s basis. Therefore, the transaction would be exempt from the transfer for value rules.
Joseph F. Stenken, JD, CLU, ChFC, is advanced sales marketing counsel at UNIFI Companies, Cincinnati, Ohio. You may e-mail him at [email protected]