Hello again and thank you for your question.
I'll start by describing the facts, based on your answer to my Request
for Question Clarification.
An employee of a company has set up an irrevocable life insurance
trust ("ILIT"). The trustees of the trust have applied for, own, and
are named beneficiaries of a variable universal life insurance policy
on the life of the employee. The trustees can tell the insurance
company how to invest the insurance premiums, and how much the cash
value of the policy grows will depend on how lucky or skilled the
trustees are in their choice of investments. The company is paying
the premiums on the policy. The ILIT is a trust for the benefit of
the employee's family (spouse, children, etc.). At the death of the
employee, the trustees will collect the death benefit (comprised of
the cash value of the investment fund plus an additional amount called
the 'at-risk amount') and use the death benefit proceeds to take care
of the employee's family in accordance with the terms of the trust.
What's important about this arrangement is that it falls outside the
restriction of Code Section 264(a)(1), which provides as a general
rule that no deduction shall be allowed for premiums on any life
insurance policy if the taxpayer (i.e. the company that is paying the
premiums) is directly or indirectly a beneficiary under the policy.
The above is clear from Treasury Reg. Section 1.264-1(b) (Premiums on
life insurance taken out in a trade or business):
"If a taxpayer takes out a policy for the purpose of protecting
himself from loss in the event of the death of the insured, the
taxpayer is considered a beneficiary directly or indirectly under the
policy. However, if the taxpayer is not a beneficiary under the
policy, the premiums so paid will not be disallowed as deductions
merely because the taxpayer may derive a benefit from the increased
efficiency of the officer or employee insured."
[I've not been able to find a web link to these regulations]
So in answer to your question, on these facts the premium payments are
not non-deductible under Section 264.
The Code section under which the premiums are deductible is Code
Section 162, which allows as a deduction all the ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on any trade or business, including a reasonable allowance
for salaries or other compensation for personal services actually
rendered.
Of course, like most compensation deductible under Code Section 162,
this compensation is income taxable directly to the employee. I say
directly in this case because the ILIT is a grantor trust described in
Code Section 677(a)(3):
"The grantor shall be treated as the owner of any portion of a trust
... whose income may be applied to the payment of premiums on policies
of insurance n the life of the grantor...."
so the income tax treatment is the same as if the employer were paying
the premium money directly to the employee as compensation.
Finally, and despite the ILIT and the employee being treated as the
same person for income tax purposes, they are different entities for
gift tax purposes. So the premium payments being made to or an behalf
of the ILIT by the employer constitute taxable gifts by the employee
to the ILIT. That gift tax liability (or use of unified credit where
applicable) is the employee's problem and responsibility, not the
employer's.
Thanks again for letting us help with your question. I do not have
the usual Google search strategy in this case because I answered your
question using my personal knowledge and direct access to the Internal
Revenue Code and Regulations. If you find any of my answer lacking in
clarity, please request clarification. I would appreciate it if you
would hold off on rating my answer until I have a chance to respond.
Sincerely,
Google Answers Researcher
Richard-ga |
Request for Answer Clarification by
droger-ga
on
27 Feb 2005 16:26 PST
If the trust (ILIT) owns the policy and is the taxpayer, and is also
paying the premiums, hasn't it "taken out a policy for the purpose of
protecting himself (itself) from loss in the event of the death of the
insured," and doesn't that make it a beneficiary (directly or
indirectly), and therefore exclude it from the language in Treasury
Reg. Section 1.264-1(b), where it states that "if the taxpayer is not
a beneficiary under the policy, the premiums so paid will not be
disallowed..."
Is the arguement that the trust is not the beneficiary, even though it
owns the policy, and would initially receive the death benefit
proceeds?
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Clarification of Answer by
richard-ga
on
27 Feb 2005 17:31 PST
Hello again:
I'm not sure I understand your question. Who is the original source
of the premium money, and who is looking to take the deduction? In
other words, where did the trust get the money to pay the premiums?
-R
|
Request for Answer Clarification by
droger-ga
on
27 Feb 2005 19:59 PST
The trust gets the money because it is a Unit of Beneficial Interest
(UBI) holder in another trust which gives it money based on a
performance based grant which results from multiple business
enterprises--many of these business enterprises have independent
relationships with both the recipient trust and the donor trust--
Both trusts are complex estate trusts, that is, common law trusts
which are structured as non-grantor, irrevocable trusts--since the
recipient trust is a complex estate trust (non-statuatory) structured
as a ILIT, the regs of the latter would likely apply
The grantor (trustor) of the trust is the insured, but the trust is a
non-grantor trust--it is irrevocable and has a completely independent
trustee
Doesn't 677 and 162 apply to grantor trusts, such as a Living Trust?
Also, what is the relationship between the IRC and the Treasury Regulations?
Where can I get access to these Treasury Regulations?
Finally, do you know of any tax court rulings, private letter rulings,
IRR, case law, published accounting opinions, law review articles, or
similar information that specifically relates to Treasury Reg. Section
1.264-1(b)?
Thank you.
D.
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Clarification of Answer by
richard-ga
on
28 Feb 2005 04:44 PST
Hello again:
"The trust gets the money because it [holds] a Unit of Beneficial
Interest (UBI) in another trust which gives it money based on a
performance based grant which results from multiple business
enterprises--many of these business enterprises have independent
relationships with both the recipient trust and the donor trust"
So clearly the grant of UBI units to the recipient trust is
related to the employee status of the insured, and is part of the
employee's compensation.
"The trust is irrevocable and has a completely independent
trustee...Doesn't 677 ... apply [only] to grantor trusts, such as a
Living Trust?
The irrevocability and independent trustee means the ILIT will be
excluded from the insured's estate at death but no, Section 677 is an
income tax provision that does apply to the trust and yes, it is a
grantor trust for income tax purposes.
"If the trust (ILIT) owns the policy and is the taxpayer, and is also
paying the premiums, hasn't it "taken out a policy for the purpose of
protecting himself (itself) from loss in the event of the death of the
insured," and doesn't that make it a beneficiary (directly or
indirectly), and therefore exclude it from the language in Treasury
Reg. Section 1.264-1(b), where it states that "if the taxpayer is not
a beneficiary under the policy, the premiums so paid will not be
disallowed..."
The business enterprises are the 'taxpayer' for these purposes,
and so long as the business enterprises are not getting the death
benefit the business enterprises are not benefitting and hence the
disallowance provisions of 264 don't apply to them.
The ILIT and the ILIT grantor are not the 'taxpayer' because the
ILIT's and grantor's tax return is not the one we're talking about.
The ILIT's income tax return (disregarding for the moment that
it's a grantor trust) would report any income the ILIT might be
earning, and the issue is not whether the ILIT gets an income tax
deduction for paying the premiums--in fact it does not get an income
tax deduction for paying the premiums, not because of Sec 264 but
because the premium expense is not a business expense of the trust.
Look at it this way. Suppose those business enterprises give
the trust $100,000 of cash, and suppose the trustees decide to put
$50,000 of the cash into insurance premiums and the other $50,000 they
use to buy a 5% T-bill that pays them $2,500 of interest each year.
Both of these are investments of the trust. Neither payment by the
trust generates an income tax deduction. The cash value growth of the
policy is tax-free (that's the way life insurance is) and the trust
(actually the grantor because of the grantor trust feature but that's
not relevant to this example) pays income tax on its $2,500 of
interest income. So Sec 264 has no relevance to the ILIT and ILIT
grantor's returns. The relevance of Sec 264 is that if it applied to
the business enterprises, they'd be unable to deduct their payment of
the $100,000 despite Sec 162. But thanks to the way Sec 264 and its
regulations are written, Sec 264 does not apply and the Sec 162
deduction is available to the business enterprises (and the
employee/insured has compensation income of $100,000).
"Also, what is the relationship between the IRC and the Treasury Regulations?
Where can I get access to these Treasury Regulations?"
I did locate the tax regulations: you can read them at
http://www.access.gpo.gov/nara/cfr/waisidx_03/26cfr1v3_03.html
Congress writes the Internal Revenue Code which is a federal law
like any other; The Treasury Department (part of the executive branch)
holds hearings and writes the regulations to help spell out how
Treasury and its enforcement arm, the IRS, will interpret and enforce
the Code.
Finally, do you know of any tax court rulings, private letter rulings,
IRR, case law, published accounting opinions, law review articles, or
similar information that specifically relates to Treasury Reg. Section
1.264-1(b)?
If I find any I'll post a further clarification.
-R
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Clarification of Answer by
richard-ga
on
28 Feb 2005 06:03 PST
I found two cases, both using Section 264 to deny the employer's
deduction because the employer was at least an indirect beneficiary of
the policy:
http://www.irs.gov/pub/irs-tege/eptt_neonatology.pdf
The Neonatology case disallows an employer's premium contibution under
Sec 264 (despite sec 162) because the business was an indirect
beneficiary.
"Section 264 does not require that the corporation be named by the
policy as the beneficiary to which the proceeds will be payable but
merely that it be "a" beneficiary."
Brock v. Commissioner (June 16, 1982)(applying Section 264 to disallow
the deduction) (no Web reference available)
"The agreement which was entered into with Mrs. Brock allows the
corporations to draw against the proceeds of the policies in order to
maintain solvency. Medical Management and its subsidiaries clearly
have a beneficial interest in the policies."
Regards,
Richard-ga
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Clarification of Answer by
richard-ga
on
28 Feb 2005 10:30 PST
The link I gave you to the Neonatology case is to the federal circuit
court decision on appeal. The quote I gave you is from the lower, Tax
Court case.
You can read more about the Tax Court case here:
http://www.taxanalysts.com/www/tadiscus.nsf/0/DCB2A18483573525852569350054F63A?OpenDocument
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