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Tax Planning and Insurance, Pt. 2: Estate Taxes and Life Insurance

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As part of AdvisorOne’s Special Report, 22 Days of Tax Planning Advice for 2012, throughout the month of March 2012, we are partnering with our Summit Business Media sister service, Tax Facts Online, to take a deeper dive into certain tax planning issues in a convenient Q&A format. In this, the seventh article, we look at life insurance proceeds and federal estate tax. 

When can a beneficiary of life insurance proceeds be held liable for payment of federal estate tax falling on the insured’s estate? 

The executor has primary liability for paying federal estate tax and is expected to pay it from the probate estate before distribution. Under IRC Section 2206, unless the decedent has directed otherwise, the executor ordinarily may recover from a named beneficiary such portion of the total tax paid as the proceeds included in the gross estate and received by the beneficiary bear to the taxable estate.

In the case of insurance proceeds receivable by the surviving spouse and qualifying for the marital deduction, IRC Section 2206 applies, if at all, only to proceeds in excess of the aggregate amount of marital deduction allowed the estate. Most states also have apportionment laws under which life insurance beneficiaries share the estate tax burden with estate beneficiaries.

It is not entirely clear whether IRC Section 2206 imposes a duty on the executor to seek apportionment, or only gives the executor the power to do so. Where the executor is unable to recover a pro-rata share of the estate tax from the beneficiary of the life insurance proceeds, the estate cannot claim a deduction under IRC Section 2054; it is a bad debt and as such is not deductible under IRC Section 2054. A legatee whose share of the estate bears the burden of tax attributable to the proceeds, however, is entitled to a bad debt deduction.

If the government is unable to collect the estate tax from the insured’s estate, the tax can be collected from the beneficiary of the life insurance proceeds up to the full amount of the proceeds if the value of the proceeds was includable in the gross estate. Any person who receives property includable in a decedent’s gross estate under IRC Sections 2034 to 2042 is liable for the tax.

It is immaterial that the insured’s will directed payment from the insured’s general estate. An insurance company holding the proceeds under a settlement option is not liable for the tax. There is a split of authority as to whether transferee liability for interest on any unpaid tax is limited to the amount of proceeds received from the decedent’s estate.

See all six articles from Tax Facts Online, part of AdvisorOne’s 22 Days of Tax Planning for 2012 Special Report.


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