90 / Are life insurance proceeds includable in the insured’s estate if someone other than the insured took out the policy and owns it at the insured’s death?

Proceeds ordinarily are not includable in the insured’s gross estate if the insured has never owned the policy and the proceeds are not payable to or for the benefit of his estate.¹ (But see Q 83.) If the terms of the policy give the insured any legal incidents of ownership, however, the proceeds may be included in the insured’s gross estate even though a third party purchased the policy and always has retained physical possession of it.²

Even though a policy says clearly that incidents of ownership belong to the insured, if it also is clear from facts outside the policy that it was the intention and belief of the parties involved in purchasing the insurance that these ownership rights were to be, and were, placed in another, courts may allow the “intent facts” to override the “policy facts.” That is, they may find that the insured did not actually possess the incidents of ownership the policy said were exercisable by the insured.³

On the other hand, even though the policy does not give the insured any incidents of ownership, an incident of ownership may be given to the insured by an outside document, such as a corporate resolution, a trust indenture, or another agreement between the insured and the third party.⁴ The fact that the insured has had no opportunity to exercise the legal incidents of ownership is immaterial.⁵ Also, if the insured causes insurance to be bought on the insured’s life by another with funds supplied by the insured and then dies within three years of the purchase, the proceeds may be includable in the insured’s estate ( Q 96). In Estate of Margrave v. Commissioner,⁶ the U.S. Court of Appeals for the Eighth Circuit affirmed a 9-7 decision of the Tax Court holding that the proceeds of a wife-owned policy, payable revocably to the trustee of a revocable trust created by the insured husband, were not includable in the insured’s estate under either IRC Section 2042 (incidents of ownership test – see Q 86) or IRC Section 2041 (general power of appointment). The IRS has agreed to follow the holding in Margrave.⁷