"Switching" Irrevocable Life Insurance Trusts
Posted by madee998 on July 28th, 2010Irrevocable life insurance trusts (”ILITs”) are commonly used to keep insurance proceeds outside the estates of the grantor-insured, the grantor’s spouse, and the grantor’s descendants (if a generation-skipping trust is used). As the name indicates, an ILIT is irrevocable and its terms cannot be amended after it is created. The irrevocability of an ILIT can create problems for grantors and their attorneys alike. For example, perhaps the ILIT is not a generation-skipping trust and the grantor now wishes to leverage his/her GST exemption with the policy or policies owned by the trust. Or maybe the grantor no longer wishes to provide for one or more of the beneficiaries of the ILIT, or desires to change the dispositive terms of the trust. So what can the grantor of an ILIT do if he/she is no longer happy with the terms of an ILIT?
The grantor can always stop making gifts to the ILIT, let the existing policy lapse, and start over with a new ILIT and a new policy. But, Maintain current policy for health or economic reasons may be preferable. The ILIT can sell the policy back to the grantor-insured, which then assigns it a new ILIT, but that is the operation of a new three-year rule (under IRC Section 2035 (start a)). Finally, if the ILIT allows, can policy be distributed to one or more of the recipient. But without trust, the political beneficiaries will not be protected from creditors, ex-spouse or estate taxes.
Transfer-for-priceRule.
IRC Section 101(a)(1) generally excludes life insurance proceeds from gross income. IRC Section 101(a)(2) limits the exclusion to the consideration paid by the purchaser for the policy (plus subsequent premiums) where there has been a transfer for valuable consideration. But, there are several exceptions to this limitation, including a transfer to the insured.
Rev. Rul. 2007-13.
Rev. Rul. 2007-13 considered two situations. In the first, a new grantor trust purchased a to trust life insurance on the grantor's life from an old agreement. Citing Rev. Rul. 85-13, which means that transactions are provided between a landlord and his / her trust grantor aside to be left for purposes of income tax, the IRS that the transfer is between two grantor trusts was a transfer for valuable consideration under IRC Section 101 ( a) (2) because the entire transaction is not considered. In other words, there was no transfer of insurance within the meaning of IRC §101(a)(2). As such, the death proceeds remain income tax free.
In the second situation, a new grantor trust purchased a policy from an old non-grantor trust. The IRS ruled that there was a transfer for valuable consideration under those facts, but the transfer was exempt because the transfer to the new ILIT is treated as a transfer to the grantor, who is the insured. Thus, as in the first situation, the insurance proceeds remain income tax free. But, unlike the first situation, the old ILIT have reportable income on the sale, if there is a gain in the policy at the time of the sale.
Precautions.
Accordingly, based on Rev. Rul. 2007-13, it is possible for the grantor of an existing ILIT, create a new ILIT (with the desired recipient and provisions), and then acquire sufficient donations or loans from the new ILIT cash in the policy from the old ILIT. But before this there are a number of problems to be solved, including the following:
1st The old ILITmust permit the trustee to sell the policy, and the sale proceeds still remain in the old ILIT to be administered.
2. If the old ILIT is a non-grantor trust, any gain in the policy sold will be subject to income taxes.
3. The grantor has to expend monies (whether by gift and/or loan) to fund the new ILIT, and has to deal with the attendant gift and GST tax consequences if gifts are used.
4. The trustee must act independently of the grantor. Too much involvement in the transaction by the grantor could result in the trustee’s incidents of ownership over the policy being imputed to the grantor, possibly resulting in the insurance proceeds being taxable in the grantor’s estate under IRC Section 2042.
5. To avoid the three-year rule, the policy must be sold for full and adequate consideration. Generally, the value of a policy is its interpolated terminal reserve value, plus the unearned premium. Treas. Reg. Sec. 25.2512-6(a), Example 4. But, it might not be to ignore sure the higher price of politics in the life settlement market could Garner.
6th The trustee of the old ILIT must be his / her fiduciary duties to the beneficiaries of the ILIT old, especially if the policy is not for the highest price and / or the sale results in some recipients will be sold from the new ILIT left to examine. In any case, before the implementation of Rev. Rul. 2007-13 technology, should the grantor shall notify the trustee of the ILIT old, that the grantor intends to make nofurther gifts to the old ILIT. Thereby, the trustee of the old ILIT may be justified in selling the policy to avoid the policy lapsing.
7. Care must be taken to assure that the new ILIT is a grantor trust for income tax purposes, but not included in the grantor’s estate for estate tax purposes. For the ILIT to be deemed “wholly owned by the grantor” for income tax purposes, intentional violations of the grantor trust rules of IRC Sections 671-678 must occur.
8. The use of Crummey powers in a grantor trust raises the question of whether the beneficiaries become co-owners of the ILIT when they allow their withdrawal powers to lapse. IRC Section 678(a). If so, the new ILIT will not be deemed to be “wholly owned” by the grantor for income tax purposes and the exception to the transfer-for-value rule will be put in jeopardy. In PLRs 200729005 through 200729016, the IRS ruled that a grantor trust is wholly owned by the grantor, despite the existence of the withdrawal powers held by the Crummey beneficiaries. But, since PLRs cannot be relied upon as precedent, it might be advisable to not use Crummey powers in the new ILIT.
9. Consideration should be given to having the beneficiaries waive any claims they may have against the grantor and the trustee resulting from the sale of the policy. But, disinherited beneficiaries may have little reason to cooperate.
10. To avoid a step-transaction argument from the IRS, some time should elapse between funding the new ILIT and purchase the policy from the old ILIT. Otherwise, the IRS argued that the transaction is essentially an indirect gift of the policy to the new ILIT, triggering a new three-year rule under IRC § 2035 (a).
Rev. Rul unanswered. 2007-13 are the tax consequences if a joint ILIT either the seller and / or purchaser of a survivor's pension policy. In this situation there are two authorities (man and woman), and therefore the joint trust is not entirely owned by oneIndividual grantors. However, Rev. Rul. 2007-13 leadership and authority for the "mediation" that does ILIT owned by a single agreement can be. However, a number of tax and tax must carefully before implementing this technology are examined. Responsibility ends and the trustee should proceed with caution and should check with their advisors, all potential risks and liabilities in this area.
This article may not be used as a punishment Protection
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