The Tax Court held that the value includible in a taxpayer's gross estate for a receivable created under split-dollar life insurance arrangements was the stipulated value of the receivable, not the much higher cash-surrender value of the insurance policies purchased under the arrangements.
Marion Levine, throughout her life, had been a successful entrepreneur and businessperson. She and her husband bought a single grocery store in 1950 and over the years built it into a 27-store chain. After her husband died, she took over the business and sold it in 1981 for $5 million. She took the proceeds from the sale and successfully reinvested the money into other businesses that she actively participated in, increasing her net worth to $25 million.
In 1988 she took a first step in estate planning, creating a revocable trust with herself as trustee. Her son, Robert, her daughter, Nancy, and her longtime accountant and business adviser, Bob Larson, were successor trustees of the trust, and Robert, Nancy, and their children were the trust's beneficiaries.
In 2008, Levine entered into split-dollar life insurance arrangements (split-dollar arrangements) that required her revocable trust to pay premiums for life insurance policies taken out on the lives of Nancy and Nancy's husband, Larry. Pursuant to the arrangements, when they terminated, Levine's revocable trust had the right to be paid the greater of the premiums it paid or the cash-surrender value of the policies (the split-dollar receivable). An irrevocable life insurance trust (the insurance trust) was set up to be the owner of these policies.
Levine's children and grandchildren were the beneficiaries of the insurance trust, and Larson was the sole member of the investment committee that managed the trust. Larson, Robert, and Nancy also acted as Levine's attorneys-in-fact and as the revocable trust's successor co-trustees (and, after 2005, its co-trustees). As the sole member of the irrevocable trust's investment committee, only Larson had the right to prematurely terminate the life insurance policies: The arrangements gave Levine, Robert, and Nancy no rights to terminate the policies or the arrangements themselves. In 2009, shortly after the split-dollar arrangements were fully set up, Levine died.
Recognizing that Levine, through her revocable trust, had made gifts to the insurance trust and its beneficiaries, the attorneys-in-fact filed gift tax returns on Forms 709, United States Gift (and Generation-Skipping Transfer) Tax Return, for 2008 and 2009. Each return reported the value of the gift as the economic benefit transferred from the revocable trust to the insurance trust. Based on the rules in Regs. Sec. 1.61-22(d)(2), the value of the gift reported on the returns was $2,644.
The attorneys-in-fact also realized that the promise by the insurance trust to pay the revocable trust had some value at Levine's death in 2009, which had to be reported on Levine's estate tax return. On Schedule G, Transfers During Decedent's Life, of Levine's Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, the value of the split-dollar receivable, as owned by the revocable trust on the alternate valuation date, was reported as an asset worth about $2 million. The IRS and Levine's estate later stipulated that the value of the split-dollar receivable was $2,282,195.
The IRS audited Levine's gift tax returns and her estate tax return. It issued a notice of deficiency for the 2008 gift tax return and a notice of deficiency of slightly more than $3 million for the estate tax return. Levine's estate challenged both notices of deficiency in Tax Court in separate cases, which the court consolidated. However, the IRS lost on the gift tax issue, with the court in 2016 holding, based on its opinion in Morrissette, 146 T.C. 171 (2016) (Morrissette I), that it was obligated to enter judgment against the IRS (Estate of Levine, No. 9345-15 (T.C. 7/13/16) (bench op.)). That issue being disposed of, the court severed the gift and estate tax cases, leaving the estate's challenge of the IRS's determination regarding the estate tax to go forward.
The IRS argued in Tax Court that Levine's estate should have reported the cash-surrender values of the life insurance policies, not the value of the receivable, on the estate tax return. The Service reasoned that:
- Under Sec. 2036, Levine retained the right to income — or the right to designate who would possess the income — from the split-dollar arrangements and under Sec. 2038, she maintained the power to alter, amend, revoke, or terminate the enjoyment of aspects of the split-dollar arrangements; and
- Even if the full values of the life insurance policies are not includible in Levine's estate under Secs. 2036 or 2038, the restrictions in the split-dollar arrangements should be disregarded under the special valuation rules provided in Sec. 2703, which would force Levine's estate to include in its taxable value the full cash-surrender values of the policies.
The estate argued that it made no transfer of property that could trigger Sec. 2036 or 2038, it retained no interest in the property that it did transfer, and, in any event, the bona fide sale for adequate and full consideration exemption applied.
After the parties settled other issues in the case through stipulation, the Tax Court was left to decide whether the value of the split-dollar receivable held by Levine's estate was $2,282,195 or the insurance policies' cash-surrender value of $6,153,478.
Secs. 2036, 2038, and 2073
Under the general rule in Sec. 2036, the value of the decedent's gross estate includes the value of any interest in any property that the decedent transferred (other than in a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, under which he or she has retained for his or her life or for any period not ascertainable without reference to his or her death or for any period that does not in fact end before his or her death (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income from the property.
Under Sec. 2038, a decedent's gross estate includes all interests in property that the decedent has at any time transferred (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, where the enjoyment of the property was subject at the date of his or her death to any change through the exercise of a power (in whatever capacity exercisable) by the decedent alone or by the decedent in conjunction with any other person (without regard to when or from what source the decedent acquired such power), to alter, amend, revoke, or terminate, or where any such power is relinquished during the three-year period ending on the decedent's date of death.
Sec. 2703 provides that, in general, the value of any property for estate tax purposes is determined without regard to (1) any option, agreement, or other right to acquire or use the property at a price less than the fair market value of the property (without regard to such option, agreement, or right), or (2) any restriction on the right to sell or use such property.
The Tax Court's decision
The Tax Court held that the only property in the estate after the execution of the split-dollar arrangements was the split-dollar receivable, and, as stipulated by the parties, its value was $2,282,195. The court found that Secs. 2036 and 2038 did not require inclusion of the policies' cash-surrender values because only the insurance trust, and not Levine, could terminate the life insurance policies, and Sec. 2703 was inapplicable to the split-dollar receivable because there were no restrictions on it.
What was transferred and what was retained
The Tax Court agreed with the IRS that the applicable statutes in Levine's case were Sec. 2036 and Sec. 2038, so it first considered what property was transferred and what rights were retained by Levine and her estate under these Code sections.
Property transferred: Under Tax Court precedent, a "transfer" is broadly defined and includes a voluntary inter vivos transfer of property. The Tax Court found that the property transferred could not be the life insurance policies because they had always been owned by the insurance trust and that it could not be the split-dollar receivable because the split-dollar receivable belonged to the revocable trust and afterwards to the estate; therefore, it was retained, not transferred. Thus, the court concluded that the property transferred was the $6.5 million that Levine had paid for the life insurance, which the court found was a voluntary inter vivos transfer under Secs. 2036 and 2038.
Rights retained: The court then looked at whether Levine had retained rights in the property transferred. Under Regs. Sec. 20.2036-1(c)(1)(i), "[a]n interest or right is treated as having been retained or reserved if at the time of the transfer there was an understanding, express or implied, that the interest or right would later be conferred." The use, possession, right to income, or other enjoyment of property is considered to have been retained or reserved "to the extent that the use, possession, right to the income, or other enjoyment is to be applied toward the discharge of a legal obligation of the decedent, or otherwise for his or her pecuniary benefit."
According to the Tax Court, while Levine transferred cash, in which she could retain no interest, she did in return receive the split-dollar receivable created and defined by the split-dollar arrangements. The receivable gave her the right to the greater of $6.5 million or the cash-surrender values of the insurance policies purchased under the split-dollar arrangements. Under the terms of these arrangements, however, Levine did not have an immediate right to this cash-surrender value. She (or her estate) had to wait until the deaths of both Nancy and Larry or the termination of the policies according to their terms. While the policies held by the insurance trust could be terminated, thereby transferring the cash-surrender values of the policies to the revocable trust, the power to terminate the policies was held by the insurance trust, which was solely controlled by Larson. Consequently, the court concluded that under the terms of the split-dollar arrangements, Levine did not have possession of or rights to the cash-surrender values of the policies.
The IRS had argued that the Tax Court should take a broader perspective and look at the split-dollar arrangements as a whole in determining its results. In particular, the IRS claimed that while the arrangements said that only the insurance trust had the power to terminate the deal and hand over the cash-surrender value to the estate,general principles of contract law allowed the estate to modify any term of the arrangements in conjunction with the insurance trust. As a result, Levine retained rights under both Secs. 2036 and 2038 that required the cash-surrender values to be included in her gross estate. The Tax Court, however, citing Helmholz, 296 U.S. 93 (1935), and Estate of Tully, 528 F.2d 1401 (Ct. Cl. 1976), determined that the language in both Secs. 2036 and 2038 refers to rights and powers created by specific instruments, not general default rules of contract that might theoretically allow modification of a contract.
The IRS also maintained that Levine, through her attorneys-in-fact, Robert, Nancy, and Larson, stood on both sides of the split-dollar transactions because Larson was a co-trustee of the revocable trust and he was also the only member of the investment committee of the insurance trust, which allowed him to control the actions of the trust. The IRS reasoned that this meant that Levine, through her attorneys-in-fact, could terminate the insurance policies at any time, causing their cash-surrender value to be paid to the revocable trust. The Tax Court rejected this argument, finding that Larson would be prevented from surrendering the insurance policies because of his fiduciary duties to the beneficiaries of the insurance trust under state law.
The IRS, anticipating the problem in its argument caused by Larson's fiduciary duties for the insurance trust, contended that he would not be violating those duties, which ran to the beneficiaries of the insurance trust, because Nancy and Robert were the beneficiaries. According to the IRS, Nancy and Robert would benefit regardless of whether the life insurance policies stayed in place or were surrendered. Thus, by surrendering the policies, Larson would not be violating his fiduciary duties to the beneficiaries of the insurance trust.
However, as the estate pointed out, the insurance trust had beneficiaries other than Nancy and Robert; Levine's grandchildren were also beneficiaries, and they would not benefit from Larson's surrendering the life insurance policies. The IRS argued that because Nancy and Robert could extinguish their children's interest in the insurance trust, Nancy and Robert were the only real beneficiaries of the trust. The Tax Court, looking at the provisions of the insurance trust, found that Nancy and Robert could not extinguish their children's interest in the trust in favor of themselves, and extinguishment could only take place by will at the death of the beneficiary doing the extinguishing. Thus, the grandchildren would remain beneficiaries of the insurance trust during the lifetime of Nancy and Robert and, because surrendering the policies would not benefit the grandchildren, Larson would breach his fiduciary duties by doing so.
The IRS, in the alternative, contended that the Sec. 2703 special valuation rules applied to Levine's split-dollar arrangements. The Service argued that Levine, through her attorneys-in-fact, placed a restriction on her right to control the $6.5 million in cash and the life insurance policies by entering into the split-dollar arrangements and that this restriction should be disregarded when determining the value of the property under Sec. 2703(a)(2).
The estate in turn argued that Sec. 2703 applied only to the property owned by Levine at the time of her death, not to property she had disposed of before, or property like the insurance policies that she had never owned. The Tax Court agreed with the estate, stating, "Our caselaw confirms the plain meaning of the Code, and tells us to confine section 2703's valuation rule to property held by a decedent at the time of her death."
The only property in Levine's estate was the split-dollar receivable she held at the time of her death, and, as the Tax Court noted, there were no restrictions on that property. Accordingly, the court concluded that Sec. 2703 did not apply to the valuation of the receivable because Levine had unrestricted control of it.
In Morrisette I, the Tax Court held, with regard to split-dollar life insurance arrangements similar to Levine's, that for gift tax valuation purposes, the split-dollar life insurance arrangements at issue were governed by the economic benefit regime set forth in Regs. Sec. 1.61-22(a)(1). However, the court, before delving into its decision of the valuation of Levine's split-dollar receivable, held that Regs. Sec. 1.61-22(a)(1) did not apply in determining the estate tax consequences of Levine's split-dollar arrangements, stating in its opinion that Regs. Sec. 1.61-22(a)(1) "seems not to cover the estate-tax consequences of split-dollar arrangements at all."
Estate of Levine, 158 T.C. No. 2