• Court upholds insurance transactions for estate—In Estate of Larry Becker v. Commissioner, T.C. Memo. 2024-089 (Sept. 24, 2024), the Tax Court ruled that the step transaction doctrine didn’t apply to an irrevocable trust’s ownership of life insurance policies on the life of the grantor, and the insurance policy proceeds weren’t included in the taxpayer’s estate pursuant to Maryland state law and Internal Revenue Code Sections 2031 and 2033.
In July 2014, Larry Becker established an insurance trust for the benefit of his spouse and children. Two of his children were named as the initial trustees. The trust applied to purchase two insurance policies on Larry’s life, with total death benefits of nearly $20 million. The policies were issued in the following months. Larry never owned the policies, didn’t have any rights, interests or powers over the policies that would be considered incidents of ownership and didn’t have or control any beneficial interests in the policies.
The trust borrowed funds from Larry to pay the initial premiums. Larry had, in turn, borrowed the funds from his insurance broker, who borrowed the funds from another individual. The broker issued promissory notes to a third-party lender for the premiums (over $1 million). Later, a separate limited liability company (LLC), ALD, that the broker owned, paid off the loans issued by the broker to become the direct creditor. Under restated promissory notes, the trust was obligated to repay ALD, and ALD took a security interest in the policies. Not long after, ALD assigned its interests in the notes to another entity, JTR.
At the end of the year, the trust entered into an agreement with LT Funding, a Georgia LLC. LT Funding assumed the obligation to pay future premiums due on the insurance policies in exchange for 75% of the total death benefits of the insurance policies, plus reimbursement for any premiums advanced by LT Funding, with interest. As part of the agreement, LT Funding was granted security interests in the policies, and under a subordination agreement, LT Funding’s interest had priority over JTR’s/ALD’s interests.
Two years later, in 2016, Larry died. Because the initial premiums had been paid up for 30 months, no premiums had been paid between the date of the agreement with LT Funding and Larry’s death. The proceeds were paid to the trust, but the various creditors disputed their rights to repayment. Under a settlement agreement among the trust, JTR/ALD and LT Funding, the trust paid LT Funding $9 million to release its claims.
Larry’s son, as executor, filed the estate tax return, which didn’t include the value of the trust-owned insurance policies. The Internal Revenue Service issued a notice of deficiency, asserting the insurance proceeds were includible in the estate under IRC Sections 2031 and 2042.
Under Maryland property law, the court determined that the trust had an insurable interest in the insurance policies because the trust’s beneficiaries were Larry’s wife and descendants, all of whom have an insurable interest. The insurable interest rule voids the initial purchase of a life insurance policy on the life of another if the purchaser doesn’t have an insurable interest. Close family members have an insurable interest. The public policy behind the rule is to avoid “gambling” on the lives of others. If the initial purchaser has an insurable interest, the policies can be transferred to third parties who don’t have an insurable interest without voiding the policy. So, the year-end agreement and grant of security interests in the policies to LT Funding didn’t interfere with the validity of the policies at purchase.
However, the IRS argued that the step transaction doctrine applied to effectively collapse the transactions, treating LT Funding as the initial purchaser of the policies. As an unrelated third party, LT Funding doesn’t have an insurable interest in the policy on Larry’s life. If it were treated as the initial purchaser, the transaction would be void under the insurable interest rule. If so, the trust would have a claim against LT Funding to recover the proceeds paid under the agreement. That right of recovery would be an asset of the estate, includible under Section 2031.
Several common law tests are used to determine if the step transaction doctrine applies. The doctrine is essentially a variation on the “substance over form” argument, under which the IRS asserts that the mechanistic form of a series of transactions should be taxed as one collective transaction.
Under the “end result” test, if the taxpayer’s subjective intent shows that the series of transactions were prearranged to achieve a particular end result, the transaction will be collapsed. The court found no evidence that Larry or the trust intended to transfer the policies to LT Funding when they were initially purchased.
Under the “interdependence” test, the court will collapse the series of transactions if the several steps are so interdependent that they wouldn’t have legal effect or meaning without completing the other steps. The court found that the trust’s purchase and transfer also didn’t apply here because the initial acquisition of the insurance policies for estate tax purposes wasn’t meaningless without the LTF Agreement, noting that the premiums were paid up for 30 months. Even if additional funding would be required later, the initial purchase entitled the trust to a $20 million death benefit on Larry’s death in the next 30 months.
Because the initial purchase was proper under Maryland law and the court held that the step transaction didn’t apply, the trust had no claim against LT Funding that would be includible in the estate.
• 2025 inflation adjustments announced—In Revenue Ruling 2024-40 (Oct. 22, 2024), the Treasury released the inflation adjustments for 2025. Estate planners should take note of the new exemption and exclusion amounts:
- Gift, estate and generation-skipping transfer tax exemption amounts: $13.99 million (up from $13.61 million).
- Annual gift tax exclusion (IRC Section 2503): $19,000 (up from $18,000).
- Top (37%) income tax bracket for estates and trusts: $15,650 (up from $15,200).
- Zero percent tax bracket for capital gains for estates and trusts: $3,150.
- Annual exclusion gift to non-citizen spouse: $190,000 (up from $185,000).
