Life insurance transfer between grantor trusts avoided the transfer-for-value rule

Plain-English summary

A married couple owned a grantor trust holding life insurance policies on their joint lives and on one spouse. A separate grantor trust owned by the other spouse proposed to buy the policies so that future premiums would be funded. The IRS divided the transaction into two parts. To the extent the same spouse was treated as owning assets on both sides, the transfer was disregarded under the grantor-trust rules. The other spouse's interest was treated as a tax-free transfer to a spouse with carryover basis under section 1041. The IRS therefore ruled that the purchase was not a transfer for valuable consideration that would limit the income exclusion for life insurance death benefits, while declining to rule on policy qualification, valuation, trust status, or estate and gift tax consequences.

Ruling snapshot

• Question: Would one grantor trust's purchase of life insurance policies from another grantor trust trigger the section 101 transfer-for-value limitation?
• Outcome: Approved. The proposed purchase was not a transfer for valuable consideration under section 101(a)(2).
• Key authorities: IRC §§ 101, 1041, and 7702; Treas. Reg. § 1.101-1(b)(4); Rev. Ruls. 85-13 and 2007-13

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201423009 Third Party Communication: None
Release Date: 6/6/2014 Date of Communication: Not Applicable
Index Number: 101.01-02
Person To Contact:
--------------------------------------------------------- --------------------, ID No. ----------------
--------------------- Telephone Number:
---------------------------------- --------------------
Refer Reply To:
CC:FIP:B04
PLR-135912-13
Date:
February 27, 2014

Legend

AB = --------------------------------------------------------
----------------------------------------------------------------------------

AC = -----------------------------------------------------------------------
------------------------------------------------------------------------------------------------

Individual A = ---------------

Individual B = ------------------

Number Y = ---

Number X = ---

Number Z = ---

Dear ------------:

This is in response to your request for a ruling dated August 13, 2013 that the purchase
of life insurance contracts is not subject to the transfer for valuable consideration rule
under § 101(a)(2) of the Internal Revenue Code.

Facts
PLR-135912-13 2

Individual A and his spouse, Individual B, are the grantors of the AC Trust. The AC
Trust, as amended, is represented to be a grantor trust for federal income tax purposes
owned by Individual A and Individual B. The AC Trust, as amended, owns and is
currently the beneficiary of Number Y life insurance contracts on the joint lives of
Individual A and Individual B and the Number X policy on Individual B (collectively, the
life insurance contracts which total Number Z policies).

Individual A, is the sole grantor of the AB Trust, which is represented to be a grantor
trust for federal income tax purposes owned by Individual A.

It is proposed that the AB Trust, which otherwise has substantial assets, purchase the
life insurance contracts from the AC Trust, as amended, to ensure the funding of
premiums for the life insurance contracts. To the best knowledge of the taxpayers
involved, the life insurance contracts being transferred between the grantor trusts
qualify as life insurance contracts under § 7702.

Law and Analysis

Section 101(a)(1) provides that, except as otherwise provided in §§ 101(a)(2), 101(d),
101(f) and 101(j), 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.

Section 101(a)(2) provides, however, that if a life insurance contract or any interest
therein is transferred for valuable consideration, the exclusion from gross income
provided by § 101(a)(1) is limited to an amount equal to the sum of the actual value of
the consideration and the premiums and other amounts subsequently paid by the
transferee.

The term “transfer for valuable consideration” is defined for purposes of § 101(a)(2) in
§ 1.101-1(b)(4) of the Income Tax Regulations, as any absolute transfer for value of a
right to receive all or part of the proceeds of a life insurance contract.

An exception to the rule of § 101(a)(2) is provided in § 101(a)(2)(A) when the basis of
the life insurance contract in the hands of the transferee is determined in whole or in
part by reference to the basis of such insurance contract in the hands of the transferor.
In such a case, the rule of § 101(a)(2) will not affect the application of the general rule of
§ 101(a)(1) which allows death benefit proceeds to be received by the beneficiaries
without the amounts been included in the beneficiaries’ gross income.

A “grantor trust” is generally disregarded for federal tax purposes. Rev. Rul. 85-13,
1985-1 C.B. 184, provides that if a grantor is treated as the owner of a trust, the grantor
is considered to be the owner of the trust’s assets for federal income tax purposes.
Under Rev. Rul. 85-13, a transaction cannot be recognized as a sale or exchange for
PLR-135912-13 3

federal tax purposes if the same person is treated as owning the purported
consideration both before and after the transaction.

Rev. Rul. 2007-13, 2007-1 C.B. 685, addresses two different factual situations in which
a life insurance contract is transferred between trusts. In Situation 1, a trust (TR1)
acquired a life insurance contract in exchange for cash from a separate trust (TR2).
TR1 and TR2 were both grantor trusts, which were treated as wholly owned by the
same grantor under subpart E of part I of subchapter J of the Internal Revenue Code of
1986. Grantor was the insured under the policy subject to the transfer. Rev. Rul. 2007-
13 holds that in Situation 1 the grantor is treated for federal income tax purposes as the
owner of the contract for applying the transfer for value limitations of § 101(a)(2).
Therefore, the transfer of the life insurance contract between the two grantor trusts that
are treated as owned by the same grantor is not a transfer for valuable consideration
under § 101(a)(2).

Section 1041(a)(1) provides that no gain or loss shall be recognized on the transfer of
property from an individual to such individual’s spouse.

Section 1041(b) provides that in the case of any transfer of property described in
§ 1041(a): (1) for purposes of Subtitle A of the Code, the property shall be treated as
acquired by the transferee by gift, and (2) the basis of the transferee in the property
shall be the adjusted basis of the transferor.

The movement of the life insurance contracts from the AC Trust to the AB Trust has two
aspects. The first aspect is that, pursuant to the rationale of Rev. Rul. 85-13, Individual
A, as a grantor of the AC Trust, as amended, proposes to transfer the life insurance
contracts to the AB Trust of which Individual A is the grantor. Thus, this aspect of the
transaction cannot be recognized as a sale or exchange for tax purposes because
Individual A is treated for income tax purposes as owning the purported consideration
both before and after the transaction. The second aspect of the transaction is that
Individual B’s interest in the AC Trust (in which she is a grantor) is being moved to the
AB Trust in which Individual B’s husband, Individual A, is the grantor. This action has
the result, under § 1041(a), as being treated as a gift to her husband, Individual A, who
pursuant to § 1041(b) receives a carryover basis in the life insurance contracts from his
wife, Individual B.

Conclusion

Based on the facts provided and the representations made, we rule that the AB Trust’s
proposed purchase of the life insurance contracts from the AC Trust, as amended, is
not a transfer for valuable consideration within the meaning of § 101(a)(2).

The ruling contained in this letter is based upon information and representations
submitted by the taxpayers and accompanied by penalties of perjury statement
PLR-135912-13 4

executed by the taxpayers. While this office has not verified any of the material
submitted in support of the ruling request, it is subject to verification on examination.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of the proposed transaction under any other provisions
of the Code or regulation, which may be applicable thereto. No opinion is expressed or
implied concerning the qualification of the Number Z life insurance contracts proposed
to be purchased by the AB Trust under § 7702 of the Code, on the propriety of any
valuation of the life insurance contracts, or on the status of either the AB or AC Trust.
Moveover, we express no opinion as to the treatment of the transaction for estate or gift
tax purposes.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent. A copy of this letter must be
attached to any federal tax return to which it is relevant.

In accordance with the Power of Attorney on file with this office, the original ruling letter
is being sent to the taxpayer with copies of this letter being sent to the taxpayer’s
authorized representatives.
Sincerely,

                                                      /S/

                                               JOHN E. GLOVER
                                               Senior Counsel, Branch 4
                                               Office of Associate Chief Counsel
                                               (Financial Institutions & Products)