326 / Are proceeds of life insurance under a split dollar plan or under a reverse split dollar plan includable in an insured’s gross estate outside of the employer-employee context?

In Revenue Ruling 79-129,¹ involving a split dollar arrangement outside of the employer-employee context, the trustee of a funded irrevocable insurance trust created by the insured, D, for the benefit of D’s spouse and children, was designated policy owner and beneficiary of proceeds of an ordinary life policy in excess of the cash surrender value at death. The trust provided that D would pay the portion of the annual premium equal to the annual increase in cash value. The policy gave the insured the right to borrow against the cash surrender value up to the total of premiums paid by the insured, where the trustee owned all other policy rights, and designated D’s estate as beneficiary of the portion of proceeds equal to the cash value at death less outstanding indebtedness. The IRS ruled that the entire proceeds, both the portion payable to D’s estate and the portion payable to the trustee, were includable in D’s estate under IRC Section 2042. ( Q 183 discusses estate taxation of funds remaining from a premium payment fund on the death of a grantor-insured of an irrevocable funded life insurance trust.)

Proceeds would not be includable in an insured’s estate under IRC Section 2042(2) where the insured’s spouse and an irrevocable trust created by the insured, but over which the insured retained no powers, entered into a split dollar arrangement and the insured held no incidents of ownership in the policy.²

Two spouses would not be treated as holding incidents of ownership under IRC Section 2042(2) where they transferred cash to an irrevocable trust, the trust purchased a second to die policy on the life of the two spouses, and the spouses entered into a collateral assignment split dollar arrangement with the trust whereby the trust would pay a portion of the premium equal to term rates, the spouses would pay the balance of the premium, and the only right held by the couple was to be reimbursed for their premium payments through receipt of cash surrender values in excess of cash surrender values at the end of the initial policy year.³