Internal Revenue Service
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smRev. Rul. 79-46
1979-1 C.B. 303
Section 2042 -- Life Insurance
IRS Headnote
Life insurance; right to prevent cancellation of policy. A decedent's right, existing at the time of death, to prevent cancellation of an insurance policy on the decedent's life that is owned by the decedent's employer by purchasing the policy for its cash surrender value if the employer decides to terminate it is an incident of ownership within the meaning of section 2042 of the Code. The insurance proceeds reduced by the cash surrender value at the time of death are includible in the decedent's gross estate.
Full Text
Rev. Rul. 79-46
Advice has been requested whether the right of the decedent to prevent the cancellation of an insurance policy on the decedent's life that is owned by the decedent's employer is an incident of ownership in the policy, under the circumstances described below.
At the date of decedent's death, the decedent's employer owned a policy of life insurance on decedent's life. The decedent's spouse was the designated beneficiary of the proceeds. Under the terms of an employment contract between the parties, the employer, at its option, had elected to pay the premiums upon the policy and keep the policy in full force and effect. The employer had the right to designate the beneficiary so long as the employer paid the premiums. However, if the employer had elected to not pay the premiums and to not keep the policy in full force and effect or if the employer, at any time after the date of issuance of the policy, had decided to surrender and terminate the policy, the employer had agreed to first give the employee the right to take an assignment of all the employer's rights and obligations. The assignment was to be made in exchange for an amount equal to the cash surrender value of the policy on the date of assignment that was to be paid to the employer.
Section 2042 of the Internal Revenue Code of 1954 provides that the value of the gross estate shall include the value of all property to the extent of the amount receivable as insurance under policies on the life of the decedent by (1) the executor, and (2) all other beneficiaries, with respect to which the decedent possessed at the date of death any of the incidents of ownership in the policies, exercisable either alone or in conjunction with any other person.
Section 20.2042-1(c)(2) of the Estate Tax Regulations provides, in part, as follows: "* * * the term 'incidents of ownership' is not limited in its meaning to ownership of the policy in the technical legal sense. Generally speaking, the term has reference to the right of the insured or the insured's estate to the economic benefits of the policy. Thus, it includes the power to change the beneficiary, to surrender or cancel the policy, to assign the policy, to revoke an assignment, to pledge the policy for a loan, or to obtain from the insurer a loan against the surrender value of the policy, etc."
The question presented is whether the right of the decedent to prevent the cancellation of the policy on the decedent's life by purchasing the policy for its cash surrender value if the employer decides to terminate the policy, is an incident of ownership within the meaning of section 2042 of the Code; and, if so, the amount includible in the decedent's gross estate.
An incident of ownership as the term is used in section 2042 of the Code is a right exercisable with respect to a life insurance policy. A right given its normal and customary meaning is an ascertainable and legally enforceable power. United States v. Byrum, 408 U.S. 125 (1972), Ct.D. 1954, 1972-2 C.B. 518. Possession of any one of the ownership incidents listed in section 20.2042-1(c)(2) of the regulations is by itself sufficient for inclusion of the proceeds in the gross estate. See Eleanor M. Schwager, 64 T.C. 781 (1975). Moreover, the courts have attached the same 2042 consequences to the existence of a power to veto the exercise of an ownership incident by another as an affirmative power in the nature of an ownership incident.
In Karagheusian v. Commissioner, 233 F. 2d 197 (2nd Cir. 1956), an insurance policy on the life of the decedent was issued pursuant to the application of the decedent's spouse. The decedent's spouse transferred the policy to a trust and under the terms of the trust agreement retained the power to alter or revoke the trust with the consent of the decedent. In holding the proceeds includible in the decedent's gross estate under section 2042 of the Code, the court stated that the decedent acting with another could modify the trust and thereby change the ultimate beneficiary of the policy. Furthermore, the court stated that it made no difference whether the decedent could have initiated changes or merely consented to them. Similarly, in Goldstein's Estate v. United States, 122 F. Supp. 677 (Ct. Cl. 1954), cert. denied, 348 U.S. 942 (1955), a policy on a decedent's life was issued upon decedent's application, but ownership and ownership incidents were vested in the beneficiary. However, the insured's consent was necessary prior to the beneficiary's exercise of any ownership incident. The court held that the decedent "in conjunction with" the beneficiary had incidents of ownership in the policy and, the fact that decedent's power "was negative or in the nature of a veto power, does not diminish its effectiveness as an incident of ownership." Schwager, cited above, involved a split-dollar policy on the decedent's life where the owner-employer upon the decedent's death, was to receive the cash surrender value of the policy and the balance was to be paid to the decedent's designated beneficiary. The employer could not change the beneficiary without the decedent's consent. Relying on the aforementioned cases, the court held the proceeds were includible in the decedent's gross estate under section 2042 of the Code.
The decedent's veto power over the exercise of an affirmative power held by another is held in suspense until affirmative action is taken by such individual. However, includibility of insurance proceeds under section 2042 of the Code does not depend on the practical ability of the decedent to exercise the power. In Commissioner v. Noel, 380 U.S. 678 (1965), Ct. D. 1893, 1965-2 C.B. 371, the decedent-insured purchased accident insurance on decedent's life at the airport immediately before take-off of decedent's flight. Physical possession of the policy was given to the decedent's spouse. The decedent was killed when the plane crashed during the flight. The Supreme Court held the insurance includible in decedent's gross estate, even though as a practical matter the decedent could not have exercised the incidents of ownership during the flight. The Court held that includibility was determined by the existence of the power and not by the practical ability to exercise the power. In United States v. Rhode Island Hospital Trust Co., 355 F. 2d 7 (1st Cir. 1966), decedent's parent applied for an insurance policy on decedent's life and kept possession of the policy for the duration of decedent's life. Under the terms of the policy the decedent had the power to change the beneficiary; and, despite decedent's lack of physical possession of the policy, the court held that the proceeds were includible in decedent's gross estate.
In the instant case, the employer did not have the unilateral power to discontinue payment of the premiums nor to surrender the insurance policy for its cash surrender value. Its power was circumscribed by the terms of the employment contract which gave the decedent the right to purchase the policy for its cash surrender value if the employer decided to terminate the policy. The decedent's contractual right enabled the decedent to ensure that the insurance policy on the decedent's life would remain in effect. Consequently, this right was of economic value to the decedent. While the decedent could only exercise this right upon the specified action by the employer, the existence of a veto power furnishes grounds for includibility under section 2042 of the Code. See Rev. Rul. 75-70, 1975-1 C.B. 301. Moreover, the requirement that the decedent pay the employer the cash surrender value of the policy does not affect the grounds for includibility, but goes to the valuation of the policy for federal estate tax purposes.
Accordingly, the right of a decedent to prevent cancellation of the insurance policy on the decedent's life by purchasing the policy from the owner for the policy's cash surrender value is an incident of ownership within the meaning of section 2042 of the Code. The amount includible in the decedent's gross estate is the amount of the insurance proceeds reduced by the amount payable to the employer; that is, the policy's cash surrender value at the time of the decedent's death.