REVENUE RULE 90-21

1990-1 C.B. 172, 1990-9 I.R.B. 13.

Internal Revenue Service
Revenue Ruling

INSURANCE GIFT; TRANSFER

Published: February 26, 1990

Section 2035. - Adjustments for Gifts Made Within 3 Years of Decedent's Death, 26 CFR 20.2035-1: Transactions in contemplation of death.

(Also Section 2042; 20.2042-1.)

Insurance gift; transfer. The gratuitous assignment of a life insurance policy by a corporation within three years of the death of the corporation's controlling shareholder is, for purposes of section 2035(d)(2) of the Code, a transfer of the incidents of ownership in the policy by the controlling shareholder.

ISSUES

(1) If, within 3 years of its controlling shareholder's death, a corporation, for less than adequate and full consideration, assigns a life insurance policy on the stockholder's life and the stockholder then disposes of control of the corporation and if the life insurance proceeds are payable to a third party for other than a business purpose described in section 20.2042-1(c)(6) of the Estate Tax Regulations, are the insurance proceeds includible in the deceased stockholder's gross estate under section 2035 of the Internal Revenue Code?

(2) If, within 3 years of death, a stockholder, for less than adequate and full consideration, disposes of the controlling interest in a corporation that owns a life insurance policy on the stockholder's life, and if the life insurance proceeds are payable to a third party for other than a business purpose within the meaning of section 20.2042-1(c)(6) of the regulations, are the insurance proceeds includible in the deceased stockholder's gross estate under section 2035 of the Code?

FACTS

SITUATION 1: D owned 80 percent of the voting stock of X corporation. In 1982, X corporation acquired a life insurance policy on D's life payable to D's child B. In 1986, X corporation assigned the policy to B for less than adequate and full consideration. In 1987, D transferred D's 80 percent interest in X corporation to D's child C. D died in 1988, and the proceeds of the policy were paid to B.

SITUATION 2: The facts are the same as in Situation 1, except that (i) X corporation retained ownership of the life insurance policy, and (ii) in 1987, D transferred to C 40 percent of the shares of X.

LAW AND ANALYSIS

Section 2033 of the Code provides that the value of the gross estate includes the value of all property to the extent of the interest therein of the decedent at the time of death. This section applies to all property beneficially owned by the decedent at death.

Section 2035(a) of the Code provides that the gross estate includes the value of all property to the extent of any interest therein of which the decedent has made a transfer within 3 years of death. The Economic Recovery Tax Act of 1981, Section 424(a), 1981-2 C.B. 256, 332, added section 2035(d) to the Code. Section 2035(d)(1) generally limits the application of section 2035(a) to estates of decedents dying before 1982. However, certain transfers by decedents dying after 1981 remain subject to the 3-year inclusion rule. Under section 2035(d)(2), section 2035(a) applies to a transfer of an interest in property which is included in the value of the gross estate under section 2036, 2037, 2038 or 2042 or would have been included under any of those sections if the interest had been retained by the decedent until death.

Section 2042(2) of the Code provides that the value of the gross estate includes the value of the amount receivable as insurance under policies on the life of the decedent by beneficiaries other than the executor, with respect to which the decedent possessed at death any of the incidents of ownership, exercisable alone or in conjunction with any other person.

Section 20.2042-1(a)(2) of the regulations provides that proceeds of life insurance that are not includible in the gross estate under section 2042 of the Code may, depending upon the facts of a particular case, be includible under some other section of the estate tax provisions of the Code. For example, if the decedent possessed incidents of ownership in an insurance policy on the decedent's own life and gratuitously transferred all rights in the policy within 3 years of death, the proceeds would be includible under section 2035.

Section 20.2042-1(c)(6) of the regulations describes the degree of voting control over a corporation that is necessary to constitute incidents of ownership in a life insurance policy owned by the corporation. The regulation explains that, if a decedent is the controlling stockholder in a corporation that holds a life insurance policy on the decedent's life, and the proceeds of the policy are payable to a third party for nonbusiness purposes, the incidents of ownership held by the corporation will be attributed to the decedent through the decedent's stock ownership and the proceeds will be included in the decedent's gross estate under section 2042 of the Code. For this purpose, a controlling stockholder is one who owns stock possessing more than 50 percent of the total combined voting power of a corporation at death.

Includibility of life insurance proceeds under section 2042 of the Code depends on the decedent's possession of incidents of ownership of the policy at death. However, includibility of life insurance proceeds under section 2035(d)(2) is based on a different rule. Section 2035(d)(2) will apply if the decedent transferred an incident of ownership in the life insurance policy during the 3-year period before death.

Rev. Rul. 82-141, 1982-2 C.B. 209, considers whether the value of life insurance proceeds is includible in a decedent's gross estate under section 2035 of the Code. In 1980, within 3 years of the decedent's death, the decedent's controlled corporation had transferred ownership of a policy on the decedent's life. The decedent owned more than 50 percent of the voting stock in the corporation at the time the policy was transferred. The ruling states that 'the principle underlying the attribution rule of section 20.2042-1(c)(6) of the regulations mandates that the incidents of ownership possessed by X [the controlled corporation] be attributed to D [the decedent] for purposes of section 2035 of the Code.' 1982-2 C.B. at 209. The ruling holds that the entire value of the insurance proceeds is includible in D's gross estate.

In Situation 1, as in Rev. Rul. 82-141, X corporation's transfer of the incidents of ownership of the policy is attributable to D because D owned the controlling interest in X corporation at the time of the transfer. The subsequent disposition of the controlling interest does not affect the analysis in Rev. Rul. 82-141 that D is treated as having transferred the incidents of ownership within 3 years of D's death. Accordingly, the value of the policy proceeds is includible in D's gross estate under sections 2035(a) and 2035(d)(2).

In Situation 2, a similar rationale applies. The incidents of ownership in a life insurance policy on D's life were transferred within 3 years of D's death, within the meaning of section 2035(d)(2) of the Code, as a result of the transfer of 40 percent of the stock of X corporation. Although the policy itself was not transferred as in Situation 1, the result is the same. As a result of the transfer of stock, D no longer held a controlling interest in X corporation. D thereby effectively released the incidents of ownership in the policy attributed to D as the controlling shareholder and such release is a transfer within the meaning of section 2035(d)(2). Accordingly, the value of the policy proceeds is includible in D's gross estate under sections 2035(a) and 2035(d)(2).

HOLDINGS

(1) Life insurance proceeds are includible in a deceased stockholder's gross estate under section 2035 of the Code if, within 3 years of death, the corporation, for less than adequate and full consideration, assigns an insurance policy on the stockholder's life and the stockholder then disposes of control of the corporation and if the life insurance proceeds are payable to a third party for other than a business purpose within the meaning of section 20.2042-1(c)(6) of the regulations.

(2) Life insurance proceeds are includible in a deceased stockholder's gross estate under section 2035 of the Code if, within 3 years of death, the stockholder, for less than adequate and full consideration, disposes of the controlling interest in a corporation that owns a life insurance policy on the stockholder's life and if the life insurance policy proceeds are payable to a third party for other than a business purpose within the meaning of section 20.2042- 1(c)(6) of the regulations.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 82-141 is amplified.

DRAFTING INFORMATION

The principal author of this revenue ruling is Susan Hurwitz of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this ruling, contact Ms. Hurwitz on (202) 566-5983 (not a toll-free call).

Rev. Rul. 90-21, 1990-1 C.B. 172, 1990-9 I.R.B. 13.