Revenue Ruling 2007-13 (Life Insurance Transfer for Value)
The Revenue Ruling consider two situations. In Situation 1, Trust 1 and Trust 2 are both grantor trusts, which are treated as wholly owned by the Grantor for Federal income tax purposes. Trust 2 owns a life insurance contract upon the life of Grantor which it transfers to Trust 1 in exchange for cash. In Situation 2, the facts are the same as in Situation 1, except that Trust 2 is not a grantor trust. At issue is whether the purchase of the policy by Trust will constitute a “transfer for a valuable consideration” within the meaning of section 101(a)(2) of the Internal Revenue Code.
Section 101(a)(2) is an exception to the general rule of Section 101(a)(1) that gross income does not include amounts received under a life insurance contract if such amounts are paid by reason of the death of the insured. Under Section 101(a)(2), if a life insurance contract, or any interest therein, is transferred for a valuable consideration, the exclusion from gross income provided by section 101(a)(1) is limited to an amount equal to the sum of the actual value of such consideration and the premiums and other amounts subsequently paid by the transferee.
Although, under applicable Treasury regulations, a transfer-for-value generally includes “any absolute transfer for value of a right to receive all or part of the proceeds of a life insurance policy,” an exception applies when a life insurance contract is transferred to the insured, to a partner of the insured, to a partnership in which the insured is a partner, or to a corporation in which the insured is a shareholder or officer.
Citing Rev. Rul. 85-13, 1985-1 C.B. 184, which provides that a transaction between a grantor of a trust that is treated as owned by the grantor for Federal income tax purposes is disregarded, the Revenue Service ruled that, in Situation 1, the transfer of the policy from Trust 1 to Trust 2 while both are grantor trusts is not a transfer for a valuable consideration within the meaning of Section 101(a)(2) of the Revenue Code. (For rulings on similar transactions, see PLRs 200636086, 200120007 and 200228019.) In effect, for federal income tax purposes, Grantor is treated as the owner of all the assets of both trusts, including both the life insurance contract and the cash received for it, both before and after the exchange. Accordingly, in Situation 1 there has been no transfer of the contract within the meaning of Section 101(a)(2), i.e., the entire transaction is disregarded.
In Situation 2, Trust 1 (the purchaser) is a grantor trust, but Trust 2 (the seller) is not a grantor trust. Therefore, Grantor is treated as the owner of the cash (but not the life insurance contract) before the exchange, and as the owner of the life insurance contract (but not the cash) after the exchange. However, although there has been a transfer for a valuable consideration in Situation 2, the transfer for value limitations of the general rule of Section 101(a)(2) do not apply because the transfer to Trust 1 is treated as a transfer to Grantor, who is the insured.
Note that, under Rev. Proc. 2007-3, 2007-1 I.R.B. 108, §§ 3.01(7) and 3.01(47), the IRS stated that it will not issue an advance ruling on the following questions:
1. Whether there has been a transfer for value for purposes of § 101(a) in situations involving a grantor and a trust when (i) substantially all of the trust corpus consists or will consist of insurance policies on the life of the grantor or the grantor’s spouse, (ii) the trustee or any other person has a power to apply the trust’s income or corpus to the payment of premiums on policies of insurance on the life of the grantor or the grantor’s spouse, (iii) the trustee or any other person has a power to use the trust’s assets to make loans to the grantor’s estate or to purchase assets from the grantor’s estate, and (iv) there is a right or power in any person that would cause the grantor to be treated as the owner of all or a portion of the trust under §§ 673 to 677 (See, e.g., PLR 9413045, in which the IRS implied — but would not rule — that the sale of two second-to-die polices, one of which was held by a trust of which the wife was the grantor, and the other of which was held by a trust of which the husband was the grantor, to a new trust that was intentionally designed to qualify as a “grantor trust” with respect to the husband and wife would not be a transfer-for-value with respect to either of them); and
2. Whether the grantor will be considered the owner of any portion of a trust when (i) substantially all of the trust corpus consists or will consist of insurance policies on the life of the grantor or the grantor’s spouse, (ii) the trustee or any other person has a power to apply the trust’s income or corpus to the payment of premiums on policies of insurance on the life of the grantor or the grantor’s spouse, (iii) the trustee or any other person has a power to use the trust’s assets to make loans to the grantor’s estate or to purchase assets from the grantor’s estate, and (iv) there is a right or power in any person that would cause the grantor to be treated as the owner of all or a portion of the trust under §§ 673 to 677.
Rev. Rul. 2007-13 would appear to offer a favorable response to the first of these questions (although it is not clear if the assets of Trust 1 and Trust 2 consisted solely or substantially of life insurance) — the transfer for value question — because the “grantor” status of the trust has been stipulated by the taxpayer who then has the responsibility on audit of establishing the accuracy of that stipulation and thus confirming the favorable nature of the response. In contrast, the revenue ruling does not favorably answer the second of the revenue procedure questions — the grantor trust question — since Rev. Rul. 2007-13 does not discuss the reason why Trust 1 or Trust 2 were in fact treated as owned or not owned by the Grantor for Federal income tax purposes.
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