How the Gifting of a Life Insurance Policy Could Trigger a Gift Tax

Payment by a client of one or more premiums would be considered a gift if the policy itself was owned by another person or party. The amount of the gift is the full premium paid. A reduction in the amount of the taxable gift would be allowed for the actuarial value of any interest in the policy’s benefits retained by the donor.

For example, if a father paid premiums on a policy owned by his daughter, he is making gifts to her each time he pays a premium. Of course, where the parties are husband and wife, the gift may qualify for the unlimited marital deduction and no adverse gift tax implications will result.

Likewise, if a client makes cash transfers to an irrevocable trust for enabling the trustee to pay premiums on one or more policies owned by the trust (or if the client makes payments directly to the insurance company), each premium payment would constitute a gift to the beneficiaries of the trust.

If a client funds an irrevocable trust by transferring income producing property to the trust to pay premiums, the fair market value of that property (in addition to the value of any policy transferred to the trust) would be subject to gift tax. But as soon as the income producing property is owned by the trust, income it produces is not deemed to be an additional gift—even if the client is considered the owner of trust income for income tax purposes.

Premiums paid by one of several beneficiaries of an irrevocable life insurance trust will be considered gifts to the other beneficiaries to the extent the payor’s payments cover their share of the premiums. Intent to make a gift is irrelevant. The IRS would determine the value of the gifts by subtracting the actuarial value of the share retained by the premium paying beneficiary from the total premiums paid.

Usually, the donor of the gift will be the party making the actual premium payments. However, if an individual assigns group term coverage to a beneficiary or to a trust on behalf of one or more beneficiaries, group term premiums subsequently paid by the individual’s employer will be deemed to be gifts from the employee to the beneficiary or to the beneficiaries of the trust. If the group insurance plan is nondiscriminatory (or if the client is not a key employee) the amount of each gift is found under Table I rates. If the employee chooses not to use the Table I rates, or the plan is found to be discriminatory (and the client is a key employee), the gift will be the actual cost of insurance on that employee. In any case, the gift would be based on the full face amount of the insurance and not merely the amount in excess of the first $50,000 of coverage.

There are many hidden gift situations. For instance, split dollar life insurance (an arrangement under which different parties share costs and benefits of a life insurance policy, see Chapter 41) often involves gift tax implications. For instance, assume a client has assigned his cash value interest in a policy in a split dollar arrangement to an irrevocable trust for his daughter. The client is making a gift of the policy, just as if he had made a gift of a previously purchased premium paying policy. So, the interpolated terminal reserve plus any unearned premium less amounts, if any, repayable to the employer would be the value of the gift.

Obviously, if, after the transfer of his interest in the policy to the trust, the client also pays premiums (including premiums paid by an employer), either directly to the insurer or as cash contributions to the trust, further gifts are made. The treatment of the split dollar arrangement depends on whether the client is the owner of the policy. Even if the trust is named as the policy owner, the client may be treated as the owner if the only economic benefit provided to the trust is the value of current life insurance protection.

If the client (or employer) is treated as owner of the policy, the employee client is deemed to have received premiums paid by the employer and then made a gratuitous transfer. What is the value of such annually recurring gifts? It appears that the value of those transfers would be measured by the same amount the employee reports each year as income.

If the trust is treated as the owner, the client (or employer) makes premium payments, and the client (or employer) is entitled to recover premiums, the client (or employer) is treated as making a loan to the trust. The client is treated as making a gift of interest on the loan to the trust. If there is no right to repayment, the entire value of the premium would be treated as a gift.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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