168 / What are the estate tax results in the insured’s estate when life insurance premiums have been paid with both community and separate funds?
Where premiums have been paid partly with the insured’s separate funds and partly with community funds, one of two basic approaches is taken, depending on local law. Under California and Washington law, a “premium tracing rule” is applied, which says that the proceeds are part separate and part community in the proportion that the premiums were paid with separate and community funds. Accordingly, in estate tax cases involving California and Washington residents in which this issue is presented, the insured’s estate includes the proportion of proceeds considered paid for with the insured’s separate property and one-half the proportion of proceeds considered paid for with community property.1
Louisiana, Texas, and probably New Mexico (and possibly also Arizona) apply the “inception of title” doctrine in determining whether such proceeds are separate or community: proceeds of life insurance bought initially as separate property remain separate property, although the community is entitled to be reimbursed for premiums paid from community funds. Conversely, proceeds of insurance bought initially as community property remain community property, although the separate estate is entitled to be reimbursed for premiums paid from separate funds.
In the case of a Texas decedent who purchased life insurance as separate property, the amount includable in the gross estate as life insurance proceeds under IRC Section 2042 ( Q 80) was the face amount of policy proceeds less the amount of premiums paid with community funds. In addition, one-half the premiums paid with community funds was separately includable in the gross estate under IRC Section 2033 as the decedent’s interest in community property.2