Tax Court Affirms Exclusion of Life Insurance Proceeds from Estate in Landmark Decision
The Tax Court recently ruled in Estate of Becker, T.C. Memo. 2024-89 that the proceeds from life insurance policies were not to be included in a decedent’s gross estate, rejecting the Internal Revenue Service’s (IRS) attempt to apply the step-transaction doctrine. This decision offers crucial guidance to estate planners working with life insurance trusts and highlights the importance of state law in determining estate tax liabilities.
Background
Larry Becker, a Maryland resident, passed away in January 2016 due to a car accident. In 2014, Becker established an irrevocable life insurance trust, the Larry Becker Irrevocable Family Trust, with his son and daughter as trustees and his wife, children, and grandchildren as beneficiaries. The trust, governed by Maryland law, was designed to hold assets, specifically life insurance policies on Becker’s life.
In 2014, Becker and the trust acquired two life insurance policies from Zurich American Life Insurance Co., with the trust designated as the sole beneficiary. The first policy had a death benefit of $11.47 million, and the second, $8 million. Becker was not the owner of the policies at any time. He relinquished all powers to alter, amend, revoke, or terminate the trust agreement.
The initial premiums for the policies were funded through loans. Becker borrowed the funds from insurance broker Barry Steinfelder, who himself borrowed from an acquaintance, Julia Wen. The trust was obligated to repay ALD the initial premium loans.
Later, the trust entered into an agreement with LT Funding LLC. Under this agreement, LT Funding was to pay future premiums, while the trust would pay LT Funding a portion of the death benefits, the advanced premiums, and interest. JTR, LT Funding, and the attorney entered into subordination agreements, with LT Funding holding the first-priority security interest in the Zurich policies.
Following Becker’s death in March 2016, Zurich paid over $19.5 million in death benefits to the trust. A dispute over the proceeds led to a settlement where the trust paid $9 million to LT Funding.
IRS Challenges and Tax Court’s Ruling
When Becker’s son, Gary Becker, filed the estate tax return in April 2017, the death benefits from the Zurich policies were not included in the gross estate’s value. The IRS issued a notice of deficiency in February 2020, asserting an estate tax liability of $4.19 million. This was chiefly based on including the insurance proceeds in the gross estate and disallowing a deduction for the payment to LT Funding.
The Tax Court was tasked with deciding whether the life insurance proceeds were correctly excluded from the estate. The IRS argued for the inclusion of the proceeds, citing the step-transaction doctrine, which would collapse a series of transactions to determine their true nature. Based on this, the IRS argued that the proceeds of the policies were primarily for the benefit for LT Funding.
The court found that the step-transaction doctrine did not apply.
The court used the Restatement (Second) of Conflict of Laws, which determines that Maryland had the most significant relationship to the transaction. Under Maryland law, the insurance contracts were valid.
The Tax Court’s decision hinged on the absence of Becker’s control and the valid inception of the insurance policies. They ultimately held that the proceeds were properly excluded from the gross estate.
Implications
This case reinforces the significance of state law in estate planning, especially where life insurance is concerned, and gives important guidance on the application of the step-transaction doctrine. The court’s analysis of the intent of the parties at the outset of the transactions and the interdependence of the steps involved in the insurance policies is important. The ruling emphasizes the need for careful planning and compliance with state laws to safeguard life insurance proceeds from estate tax liabilities.
Conclusion
The Estate of Becker decision serves as a reminder that estate tax is a complex area. This case underscores the importance of consulting with qualified professionals to properly structure estate planning and ensure that the intent of the estate owner is carried out.
