– By Marc Schwartz J.D. CLU, and Marty Flaxman J.D.
A recent tax court case ruling in favor of the taxpayer in an intergenerational Split Dollar arrangement has propped open a “discounting” planning door that, up to now, the IRS had tried to slam shut. In the Estate of Clara M. Morrissette et al v. Commissioner, the tax court ruled that an intergenerational Split Dollar arrangement is covered by Split Dollar Regulations Section 1.61.22. In plain English, the ruling establishes that single-premium life insurance policies, held in irrevocable trusts, can be taxed under the Split Dollar Economic Benefit regime, and are not required to use the Loan regime, as the IRS had insisted. For the taxpayer this was very good news. Here are some of the facts, courtesy of AALU’s Washington Report (WRN 16.05.10_1) from 10 May, 2016.
“Three dynasty trusts were established on behalf of the decedent, one for each of her sons. In 2006, six non-equity economic benefit so-called intergenerational split-dollar arrangements were created between Clara Morrissette’s revocable trust and each of the dynasty trusts. Her revocable trust advanced a total of $29.9 million as one-time single premiums to the dynasty trusts to enable them to purchase insurance on the lives of each of her three sons. Clara died in 2009 with the arrangements still in place.
“The estate valued the amounts receivable by the revocable trusts from the dynasty trusts at $7.497 million. The IRS argued the arrangement was a gift at inception for the full $29.9 million dollar amount of the advances. That determination resulted in a gift tax deficiency of $13.8 million and a penalty of $2.7 million. The estate disputed the deficiency by filing a petition in Tax Court.
“The estate filed a partial summary judgment motion with the Tax Court confirming that the arrangements were in fact economic benefit split-dollar arrangements under Treasury Regulations Section 1.61-22, and the court entered a summary judgment in favor of the estate.
The IRS’s argument was essentially preemptive. “The IRS has been arguing for most of a decade that single premium split-dollar arrangements could not use the economic benefit regime of the Regulations, but instead had to use the loan regime, because they provided ‘other benefits,’ or alternatively that the single premium payments ‘prepaid’ all future economic benefits provided under the arrangement, or that since future premiums had been prepaid, the arrangements were, in effect, reverse split-dollar arrangements, and under Notice 2002-59, term costs could not be used to measure the benefit to the donee trust.
“If the loan regime applied, since no interest was provided, the arrangement was a gift term loan under the Regulations, with the discounted present value of all of the imputed interest treated as a gift in the first year of the arrangement; if the single premium prepaid future economic benefits, they were all gifts in the first year of the arrangement.”
The tax court disagreed with the Service’s position and ruled in favor of the taxpayer. But the tax court pointed out very early in its opinion that it was ruling only on the applicability of the Split Dollar regulations to the arrangements, and not on the discounted gift valuation by the taxpayer’s estate. The appropriateness of that discounted valuation, which is really at the heart of the dispute, has yet to be decided. If, however, that future decision comes down in favor of the taxpayer, “this technique may become a major means of transferring significant amounts of family wealth at greatly reduced tax costs.” (op. cit. AALU Washington Report)
In the meantime, the Morrisette case, as it stands today, provides an effective way to pay substantial premiums using intergenerational Split Dollar arrangements without incurring large gift tax liabilities and is very likely something of interest you can discuss with your centers of influence.
We’ll keep you apprised of what happens next on the discounted valuation issue. Stay tuned.