88 / If an insured holds incidents of ownership at death as a fiduciary or by reason of a retained right to remove a trustee and appoint another, will the life insurance proceeds be includable in the insured’s estate?

Revenue Ruling 84-179¹ provides that incidents of ownership held by the insured in a fiduciary capacity will cause the proceeds to be included in the insured’s estate only if (1) the incidents are exercisable for the insured’s personal benefit, or (2) the insured transferred the policy or at least some of the consideration for purchasing or maintaining the policy to the trust from personal assets and the incidents of ownership devolved upon the insured as part of a prearranged plan involving the participation of the insured. The IRS states that this position is consistent with Skifter, Fruehauf, and Hunter, court of appeals decisions discussed below.

The regulations say that a decedent is considered to have an “incident of ownership” in an insurance policy on the decedent’s life held in trust if, under the terms of the policy, the decedent (either alone or in conjunction with another person or persons) has the power (as trustee or otherwise) to change the beneficial ownership in the policy or its proceeds, or the time or manner of enjoyment thereof, even though the decedent has no beneficial interest in the trust.² The IRS says it will read this regulation in accordance with its position adopted in Revenue Ruling 84-179, above. The courts have taken three different views of the regulation:

First, the U.S. Court of Appeals for the Sixth Circuit has held that the possession by the insured of incidents of ownership in a fiduciary capacity is not enough to bring the proceeds into the insured’s estate under IRC Section 2042(2) unless the insured had the power at death to benefit the insured or the insured’s estate by exercising any of the incidents.³ This also appears to be the view of the Tax Court.⁴ See also Estate of Jordahl v. Commissioner,⁵ where the Tax Court held that the decedent’s right, as trustee of a funded life insurance trust of which the decedent was grantor and in which the decedent had an income interest, to borrow against the policies to keep them in effect if trust income was insufficient, was not an incident of ownership because in fact the income never was insufficient. The court, in Jordahl, also ruled that the decedent’s reservation of the right, as grantor, to substitute “other policies of equal value” for those held in trust at any time was not an incident of ownership.