|
 |
Backdating Can be Tricky in Irrevocable Trusts Jan. 29, 2001 (Principal Financial Group) Irrevocable trusts funded with life insurance can cost-effectively provide liquidity outside the grantor/insured's estate to pay estate taxes and expenses. Backdating policy applications can reduce premiums but may result in an issue date preceding the existence of the trust. Existing law suggests this does not create incidents of ownership attributable to the insured that could cause estate tax inclusion or a possible three-year rule problem. Removing the policy proceeds from the insured's estate is the key to an irrevocable trust. The Internal Revenue Code (IRC) provides that if an insured owns a policy on her life or any incidents of ownership in the policy at death or transfers incidents of ownership in the policy within three years of death, the policy proceeds will be included in her estate. To avoid inclusion, the insured should never own the policy or any incidents of ownership in the policy.
If the insured funds the trust by transferring an existing policy that she personally owns, the insured must survive the transfer by three years for the proceeds to be excluded from the insured's estate. Ideally, the trust will be funded with a brand new policy on the grantor's life originally applied for and purchased by the trustee. If the trust is properly drafted, the proceeds will be excluded because the insured will never possess any incidents of ownership in the policy. When a policy is backdated to save age, the application date remains the same, but the insured's most recent birthday is used as the policy issue date and the premium is calculated using that age. The lower age reduces premium. Backdating may result in an issue date preceding the existence of the irrevocable trust. Could an issue date preceding the trust creation date cause incidents of ownership to be attributed to the insured? Is there a possible three-year rule problem? Although there is no authority directly on point, case law and reasoning suggest not.
The Leder Case
In Leder v Commissioner, 90-1 USTC 60,001 (10th Cir. 1989) the court concluded that because the decedent never possessed any incidents of ownership in the policy, the proceeds could not be included under section 2042. Thus, there is no application of the three-year rule.
The court noted that the terms of the policy stated that only the owner was entitled to the rights of the policy and nothing under state law could be construed to give a non-owner rights in the policy. Because the decedent never had any rights in the policy, the proceeds could not be included under the three-year rule. Similarly, backdating should not be considered to give the insured incidents of ownership in the policy. No policy could exist before the application, thus no incidents of ownership in the policy could exist before the application. Although the policy issue date precedes existence of the trust, the trustee will make the actual application after creation of the trust. Thus, the trustee should own the policy and all incidents of ownership from the date of application forward. The insured will never possess any incidents of ownership in the policy.
Although there is no authority directly on point, existing case law suggests that backdating a policy should not give the insured incidents of ownership in the policy. No policy exists prior to the application and the trustee is the sole owner of the policy from the moment it is created. Backdating is an administrative change that the trustee requests as part of his or her role as a prudent fiduciary to the trust. |
|
|
|||||||||||||||||||||||||||||
|
||||||||||||||||||||||||||||||||
|
|
||||||||||||||||||||||||||||||||
|
||||||||||||||||||||||||||||||||
