Premier analysis of federal legislative and regulatory developments for the nation’s 2,000 most advanced life insurance planners, focusing on business, estate, qualified and nonqualified retirement planning. Counsel AALU Buchanan Ingersoll & Rooney PC PricewaterhouseCoopers David J. Stertzer, Chief Executive Officer Gerald H. Sherman William Archer Tom Korb, Vice President of Policy & Public Affairs Stuart M. Lewis Donald Carlson Marc R. Cadin, Vice President of Legislative Affairs Deborah M. Beers Sarah Spear, Director of Policy & Public Affairs Keith A. Mong Ricchetti, Inc. Anthony Raglani, Asst. Dir. of Policy & Public Affairs Steve Ricchetti Jeff Ricchetti Federal Policy Group Sutherland Asbill & Brennan LLP 2901 Telestar Court, Falls Church, Virginia 22042 Ken Kies Stephen E. Roth Toll Free: 1-888-275-0092 Fax: 703-641-8119 Matthew Dolan Eric A. Arnold www.aalu.org AALU Bulletin No: 09-76 June 26, 2009 Subject: IRS Rules Favorably On Income, Gift And Estate Tax Consequences Of Pre-2002 (Grandfathered) Split-Dollar Agreement Between Trust And Partnership Major References: PLR 200925003 Prior AALU Washington Reports: 09-04; 08-107; 08-47; 03-95 MDRT Information Retrieval Index Nos.: 2500.00; 7400.021; 7400.022; 7400.024 SEE THE CIRCULAR 230 DISCLAIMERS APPENDED TO THE CONCLUSION OF THIS WASHINGTON REPORT. The Revenue Service has ruled, in a private letter ruling (PLR 200925003), that the payment of premiums by a life insurance trust (Trust) and a partnership (Partnership) under a pre-final regulations (grandfathered) collateral assignment non- equity split-dollar life insurance agreement (the Agreement) is neither income to, nor gifts by, the grantor, and that any policy proceeds payable to Trust is not included in the grantor's (Taxpayer's) gross estate. On Date 1, Taxpayer established Trust for the benefit of his issue. On Date 2, which is stated to be pre-2002, Trust purchased an insurance policy on Taxpayer’s life. Trust was designated the policy's owner and beneficiary. Also on Date 2, Trust and Partnership entered into the Agreement. Partnership is a limited liability limited partnership with two general partners, including a corporation of which Taxpayer is the sole shareholder. Under the Agreement, as owner of the policy, Trust may exercise all ownership rights, except the rights of the Partnership as collateral assignee. These Trust- exercisable rights include the right to borrow against the cash value of the policy. 2 Pursuant to the Agreement, Partnership will pay all of the policy premiums and Trust is obligated to repay Partnership that portion of the annual premiums equal to the lesser of: (1) the applicable amount provided in the P.S. 58 tables set forth in Rev. Rul. 55-747, 1955-2 C.B. 228 (or the tables and rates as may be in use under applicable treasury regulations for the date on which the determination is made); or (2) the insurance carrier's rate for one-year renewable term insurance. Upon the death of Taxpayer, the Agreement terminates and Partnership is to receive a portion of the proceeds of the policy equal to the greater of premiums paid (less any Partnership loans against the policy) or cash surrender value (reduced by any Partnership loans against the policy), i.e., the Agreement is a non-equity arrangement. Trust is designated beneficiary of the balance of the insurance proceeds. Prior to the death of Taxpayer, the Agreement may be terminated unilaterally by Partnership or Trust. The Agreement will also terminate upon the dissolution or bankruptcy of Partnership. Within 30 days of termination, Trust is to pay Partnership the cash value of the Policy (reduced by any Partnership loans against the policy). Taxpayer represented that the Agreement has not been modified in any manner since Date 2, and that Taxpayer will dispose of his interest in the general partner of Partnership. On these facts, the Revenue Service ruled as follows: Ruling (1): The payment of premiums by Trust and Partnership pursuant to the Agreement is not income to, or a gift by, Taxpayer. With respect to the first issue, the Revenue Service noted that, since the Agreement was entered into on a date that was prior to 2002, Taxpayer, pursuant to Notice 2002-8, Part III., may, to the extent provided by Rev. Rul. 66-110, as amplified by Rev. Rul. 67-154 (and pending the issuance of future guidance), continue to determine the value of current life insurance protection by using the insurer's lower published premium rates that are available to all standard risks for initial issue one-year term insurance. The Service also cited Notice 2002-8, Part IV.2, which provides that, for split-dollar life insurance arrangements entered into before the date of publication of final regulations (September 17, 2003) - see our Bulletin No. 03-95 - , in cases where the value of current life insurance protection is treated as an economic benefit provided by a sponsor to a benefited person under a split-dollar life insurance arrangement, the Service will not treat the arrangement as having been terminated (and thus will not assert that there has been a transfer of property to the benefited person by reason of termination of the arrangement) for so long as the parties to the arrangement continue to treat and report the value of the life insurance protection as an economic benefit provided to the benefited person. The taxation of the split-dollar life insurance arrangement between Trust and Partnership is not subject to the final split-dollar regulations because the Agreement was entered into on or before September 17, 2003 and, as represented by Taxpayer, has not been materially modified after that date. Instead, the taxation of the arrangement is determined under prior law, including Rev. Rul. 64-328 and Rev. Rul. 66- 110. Therefore, because, under the terms of the Agreement, Trust will pay the portion of the premium equal to the cost of current life insurance protection, Partnership will pay the balance of the premium, and Partnership will be entitled to receive an amount equal to the greater of premiums paid or cash surrender value at the death of Taxpayer, the payment of the premiums by Partnership under the terms of the Agreement, will not result in income to, or gifts by Taxpayer, provided that the amounts paid by Trust for 3 the life insurance benefit that Trust receives under the Agreement is at least equal to the amount prescribed under Rev. Rul. 64-328, Rev. Rul. 66-110, and Notice 2002-8. The Service made the caveat, however, that, if some or all of the cash surrender value is used (either directly, or indirectly through loans) to fund the Trust's obligation to pay premiums, Partnership (i.e., the partners) will be treated as making a gift at that time. Ruling (2): Any policy proceeds that are payable to Trust will not be included in Taxpayer's gross estate under Revenue Code section 2042(2). That Section provides the value of a decedent's gross estate shall include the proceeds of all life insurance policies on the decedent's life receivable by beneficiaries other than the executor of the decedent's estate, to the extent that the decedent possessed at his death any incidents of ownership exercisable either alone or in conjunction with any other person. Applicable Treasury Regulations provide that "incidents of ownership" is not limited in its meaning to ownership of a policy in the technical legal sense. Generally, the term has reference to the right of the insured or his estate to the economic benefits of the policy. Thus, it includes power to change the beneficiary, to surrender or cancel the policy, to assign the policy, to revoke an assignment, to pledge the policy for a loan, or to obtain from the insurer a loan against the surrender value of the policy. Without further discussion, the Service concluded that since Taxpayer will dispose of his interest in the general partner of Partnership, the proceeds of the policy payable to the Trust will not be included in Taxpayer’s estate under section 2042(2). We note, however, that if Taxpayer retains any interest in Partnership, even as a limited partner, his estate will be increased by the portion of the cash value (or premiums, if greater) of the policy that is receivable by the Partnership on his death. PLR 200925003 may be the first ruling on a grandfathered split-dollar arrangement that addresses the arrangement's income tax aspects. Previous rulings have considered the gift and estate tax consequences. (See, e.g., PLRs 200851013, 200848002 and 200822003, discussed in our Bulletins Nos. 09-04, 08-107, and 08-47.) Any AALU member who wishes to obtain a copy of any of PLR 200925003 may do so through the following means: (1) use hyperlink above next to “Major References,” (2) log onto the AALU website at www.aalu.org and enter the Member Portal with your last name and birth date and select Current Washington Report for linkage to source material or (3) email Anthony Raglani at email@example.com and include a reference to this Washington Report. In order to comply with requirements imposed by the IRS which may apply to the Washington Report as distributed or as re-circulated by our members, please be advised of the following: THE ABOVE ADVICE WAS NOT INTENDED OR WRITTEN TO BE USED, AND IT CANNOT BE USED, BY YOU FOR THE PURPOSES OF AVOIDING ANY PENALTY THAT MAY BE IMPOSED BY THE INTERNAL REVENUE SERVICE. In the event that this Washington Report is also considered to be a “marketed opinion” within the meaning of the IRS guidance, then, as required by the IRS, please be further advised of the following: THE ABOVE ADVICE WAS NOT WRITTEN TO SUPPORT THE PROMOTIONS OR MARKETING OF THE TRANSACTIONS OR MATTERS ADDRESSED BY THE WRITTEN 4 ADVICE, AND, BASED ON THE PARTICULAR CIRCUMSTANCES, YOU SHOULD SEEK ADVICE FROM AN INDEPENDENT TAX ADVISOR. The mission of AALU is to promote, preserve and protect advanced life insurance planning for the benefit of our members, their clients, the industry and the general public. For more information about how AALU’s advocacy efforts help protect your business and the advanced life insurance marketplace, visit our website at www.aalu.org, or call toll free 1-(888)-275-0092.
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