Irrevocable Life Insurance Trusts (ILITs) Still Relevant?

Transcription

1 Irrevocable Life Insurance Trusts (ILITs) Still Relevant? H. Amos Goodall, Jr., CELA Pennsylvania Bar 24 th Annual Estate Law November 14, 2017 Presenter H. Amos Goodall, Jr., CELA Certified as Elder Law Attorney by National Elder Law Foundation 328 South Atherton Street State College, PA (814) (814) (fax) 2 1

2 Theory of Insurance From consumer s prospective Most insurance spread the risk Life Insurance spread the risk/investment Note: Hybrid Insurance products From company s perspective Claims experience (mortality, etc.) Persistency Experience Investment Acuity 3 Types of Life Insurance Term Life Renewable Premium Whole Life Level Premiums Cash value Endowed Age 4 2

3 Tax Treatment of Life Insurance Contract Generally not taxed for income tax purposes Annual increases in cash value Death Benefit Early Termination excess of cash value over premium payments is ordinary income. E.g., $100k death benefit life insurance with $30k cash value. Cancel after 20 years. Premiums $1k/year. $10k ordinary income; balance (i.e., premiums paid treated as a return of capital) 5 Tax Treatment of Life Insurance Contract Lapse tax bomb If cash value is being used to pay premium, considered a loan. If loan equals cash value, company will cancel the contract (early termination to repay the loan). Tax gain is based on the full cash value before loan repayment One strategy to consider a year of so before policy lapses, donate it to a charity which can cash it in. 6 3

4 Death Taxes on Life Insurance PA Not taxed US Not taxed if: Existing policy not transferred by insured within three years of death No incidents of ownership retained 7 Life Insurance Incidents of Ownership [t]he term incidents of ownership is not limited in its meaning to ownership of the policy in the technical legal sense. 26 CFR (c)(2) Actual Ownership Power to change beneficiary Power to cancel or surrender policy Power to assign policy Power to pledge policy as security 8 4

5 Irrevocable Life Insurance Trust Original Purpose: remove insurance proceeds from insured s federal taxable estate. Who has a taxable estate? In 2017, 2 out of every 1,000 decedents (0.2%) will owe federal estate tax=5,500 decedent taxpayers (including nationally 80 small farms or businesses) Chye Ching Huang et al, Ten Facts You Should Know About the Federal Estate Tax, Center on Budget and Policy Priorities (10/17/2017) tax/ten factsyou should know about the federal estate tax 9 Irrevocable Life Insurance Trust Continuing Validity remove from insured s estate Completed Gift Creditors Department of Human Services Insurance Agents love using jargon ILIT 10 5

6 Funding Irrevocable Life Insurance Trust Transfer existing policy Gift of Cash Value three year lookback for IRS 5 year lookback for PA DHS Note: Insured should be settlor; if beneficiary is settlor transfer could be deemed as a transfer of retained life estate under 26 USC 2036 Transfer of Funds; Trustee applies and purchases new policy on Settlor(s) Simply Gift of premium (See Crummy below) 11 Trustee Probably not the insured since incident of ownership Any other interested party spouse, non insured beneficiaries, etc. with ascertainable standard probably okay Rose v. US 511 F.2d 259 (5 th Cir. 1975) but see Estate of Rockwell v. Commissioner 779 F. 2d 931 (3 rd Cir. 1985) retain incident of ownership even with no possibility of economic benefit 12 6

7 Generation Shipping Tax Considerations Irrevocable trust, all of whose beneficiaries are skip persons is a skip person. Transfers to such a trust are direct skips and subject to GSTT Exemption needs to be allocated Note: Including Non Skip persons as 25% beneficiaries can eliminate GST Trust treatment. See 26 USC Crummey doesn t mean crummy Problem: Gift by transfer to irrevocable trust is not subject to treatment under annual exclusion rules. To transferee beneficiary it is a future interest Estate and Gift Tax Limits $5.6 million/person; $11.2 million/married couple 2018 Annual Gift Tax Exclusion $15,000 How to Convert gift in trust to present interest gift 14 7

8 Crummey elements Give named persons the right to withdraw funding payments (typically but not always annual premiums) for stated period. Typically 30 days Minor Beneficiary notice sufficient without an appointed guardian provided there is no impediment to such an appointment. Rev. Rul , C.B. 321 Must be notified of right of withdrawal Waiver of notice can prevent annual exclusion treatment TAM Post Notice waiver of withdrawal??? After lapse of right of withdrawal, irrevocable trust provisions govern. 15 Asset Treatment During Withdrawal Period Treated as a general power of appointment Asset of person who may make the withdrawal Crummey Power Holder (CPH) Income recognized during withdrawal period is taxed to CPH Death during withdrawal period causes inclusion of property subject to withdrawal in CPH s estate Release or exercise of withdrawal power is deemed to be a transfer of property subject to that power by CPH Safe Harbors Remainder interest pours into CPH estate if death before trust terminates 5&5 lapse, hanging withdrawal right 16 8

9 Who Has Right of Withdrawal Typically Remainder Beneficiaries Needs Benefit Programs (e.g., Medicaid) implications asset Give Right of withdrawal to someone else? Estate of Cristofani v. Commissioner, 97 T.C. 74, 84 (T.C. July 29, 1991); Estate of Kohlsaat v. Commissioner, T.C. Memo (T.C. May 7, 1997) Contingent beneficiaries maybe okay PRACTICE POINTER: READ DECISIONS AND BE CAREFUL. IRS IS NOT HAPPY where CPH is neither current income beneficiary nor remainder person whose interests are vested, CPH failure to exercise withdrawal power will be suspected to arise from a prearranged understanding with the donor, and the rights might not be viewed as a gift of a present interest. 17 ILITS Planning Opportunity Many parents of children with disabilities have limited resources How to provide after death ABLE Act d 4 A (payback) and d 4 C (pooled trusts) C 2 B ii trust (sole benefit like payback) Distribution restrictions sole benefit Post mortem transfer restrictions Common Law Trust e.g. ILIT 18 9

10 Benefits of ILIT for Medicaid Planning No restrictions on distribution provisions apart from routine SNT requirements No restrictions on post mortem distributions Can leverage limited resources, especially with second to die policy Can be structured to avoid parents Medicaid transfer penalties de minimis monthly funding payments (1/12 of annual premium) Purchase policy, make first year premium payment, transfer as existing policy to ILIT 19 10