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Charitable Deduction Disallowed for Gift of Life Insurance,
Estate Planning Journal, Jul/Aug 1991 |
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Estate Planning
Journal (WG&L) |
CURRENT TAX DEVELOPMENTS
Author:
By JACQUES T. SCHLENGER, ROBERT E. MADDEN, LISA H.R. HAYES
JACQUES T. SCHLENGER is a member of the Maryland Bar, and Senior
Tax Partner of the law firm of Venable, Baetjer and
Howard,
A popular and
heavily promoted method of charitable giving is for a donor to purchase an insurance policy
on her life
and then transfer ownership of the policy to her favorite charity. The charity is listed
as the beneficiary of the policy; however, the donor continues to pay any
premiums due. The donor then claims a charitable contribution in the years she
pays the initial premium and all subsequent ones. This type of gift was
recently disallowed by the Service in Ltr. Rul.
9110016 for a
A was an independent
contractor of, and a past contributor to, a specific charity (the Charity). A wanted to make a gift to the Charity of an insurance policy
on her life.
A intended to purchase the policy and name the Charity as the
beneficiary of the proceeds. When A received the policy, she planned to
irrevocably assign it to the Charity. She intended to pay the future
premiums, though there was no formal agreement between A and the Charity stating
that she would do so. A agreed that the Charity did not
have an insurable interest in her life.
A requested the
following rulings from the Service:
(1.) That A would be entitled to an
income tax charitable deduction, pursuant to Section
170(a)(1) within the limits of Section
170(b)(1)(A) , for the amount of the initial premium of the policy and any
subsequent premiums she paid.
(2.) That A is entitled to a gift tax
charitable deduction under Section
2522(a)(2) for the initial premium payment and
future premium payments.
(3.) That, if A dies within three years
of the gift of the policy to the Charity and the proceeds are included in her
gross estate under Section
2035(a) , A's estate will be entitled to an estate tax charitable
deduction under Section
2055(a)(2) .
(4.) That, if A
survives the policy gift date by three years, the proceeds will not be included
in her gross estate.
The Service
began its analysis by addressing ruling request 1. It immediately cited Section
3205(b)(2) of the
Under the
facts presented by A, she intended to obtain an insurance policy
on her life
and transfer it to an entity that did not have an insurable interest in her life. The Service
determined that this transaction would violate
Upon A's
death the insurance
company might not have to pay the policy proceeds to the Charity. If the
insurer did pay, A's estate might be able to maintain an action under
the provisions of Section 3205(b)(3) to recover the life insurance
proceeds from the Charity.
The Service
next reviewed the rules regarding deductions for charitable contributions found
in Section
170 and Regs. 1.170-1 and -7
. A claimed that she would be entitled to a charitable
contribution deduction for the premiums paid because the organization to which
she contributed the policy was tax-exempt under Section
501(c)(3) . Because the definition of a
charitable contribution found in Section
170(c)(2) includes essentially the same requirements found in Section
501(c)(3) , a donation to the Charity could potentially qualify as a
charitable contribution and be deductible under Section
170(a) .
Under Section
170(f)(3)(A) , a donor generally can take a charitable contribution deduction
for a transfer of an interest in property (not made by a transfer in trust)
that is less than the donor's entire interest only if the value of the interest
contributed would be allowable as a deduction under Section
170 if the interest had been transferred in trust. Certain exceptions
to this rule (for contributions of (1) a remainder interest in a personal
residence or farm, (2) an undivided portion of the taxpayer's entire interest
in the property, and (3) a qualified conservation contribution) are found in Section
170(f)(3)(B) .
Section
170(f)(2) allows a deduction for certain
charitable contributions of property in trust. Such an interest must be a
remainder interest in a charitable remainder annuity trust or unitrust, or a pooled income fund, or an income interest in
the form of a guaranteed annuity or a fixed percentage of the fair market value
of a trust.
In the
present situation, A was unable to donate to the Charity her
entire interest in the insurance policy because, since the transaction
violated New York law, the insurer might not have to pay on the policy and any
payment made might be recoverable by A's
estate. Instead, A would be donating a partial interest in the property
not in trust. It would generally not be a deductible contribution under Section
170(f)(3)(A) because it would not have been
allowable if it had been transferred in trust since it was not the requisite
income or remainder interest.
The Service
agreed that it could be argued that A was contributing her whole
interest and not a partial interest because only the insurer and A's
estate would have the right to deny the Charity the proceeds. A, herself,
could not recover the policy or the proceeds. This argument failed, however,
because A did have the power to name in her will her heirs who would
receive the policy proceeds if the estate recovered them. Therefore, A
was able to transfer only a partial interest in the policy.
The Service
looked at several Revenue Rulings that addressed similar issues. In Situation 1
of Rev.
Rul.
76-143 , 2 the taxpayer
contributed the cash surrender value of a policy on his life to a
college. He retained the right to name or change the beneficiary and to assign
the balance of the policy proceeds. The taxpayer was not allowed a charitable
contribution deduction because the gift was less than an entire interest in the
property.
Regulation
1.170A-7(b)(1)(i) allows a contribution
for an undivided portion of a donor's interest in property, but only if the
gift includes a fraction or percentage of each and every substantial interest
and right the donor owned in the property, and the gift extends over the entire
term of the donor's interest in the property. The taxpayer in Rev.
Rul.
76-143 did not make such a gift; therefore, the deduction was disallowed.
The Service noted that even if the taxpayer had irrevocably designated the
beneficiary of the policy prior to making the gift, in order to create a
remainder interest that would constitute the taxpayer's entire interest, a
deduction for the transfer would have been disallowed because such action by
the taxpayer would have been construed as an attempt to avoid Section
170(f)(3)(A) .
The Service
in Ltr. Rul.
9110016 found the rights retained by A were similar enough to those
retained in Rev.
Rul.
76-143 to reach the conclusion that A would not be transferring
her entire interest in the property within the meaning of Section
170(f)(3)(A) . The rights retained by A could be ignored only if they
were insubstantial, 3 which was not the
case. The Service concluded that A did not meet the requirements for
making a deductible contribution of an undivided portion of her interest in the
property.
The Service
next examined whether, under Regs. 1.170A-1(e) and 1.170A-7(a)(3) , the possibility that the Charity's rights
to the proceeds would be divested was so remote as to be negligible. According
to the Service, in Rev.
Rul.
73-1 , 4 a contribution to a charity that is
subject to the future possibility of being divested of its rights by actions of
the donor is not deductible under Reg.
1.170A-1(e) . In that Ruling, a donor contributed to a charity the
amount he paid in excess of the value of an annuity that he purchased from the charity. He
retained the power to have the entire purchase price returned to him at some
future date before the annuity payments began. The Service concluded that in
this situation there was more than a remote chance that the charity would not
get to keep the funds.
In A's
situation, only her estate could reclaim the property. The Service found that
the possibility of that happening was less remote than A, herself,
revoking the gift if she had that power. The Service contrasted A's
situation with Rev.
Rul.
77-148 5 where sufficient remoteness
was found. In that Ruling, the taxpayer contributed timberland to a charitable
organization that was transferring it to the U.S. Government for use as a
wildlife preserve. The taxpayer retained mineral and timber rights in the
property, but they were exercisable only if the
The Service
also referred to Briggs, 6 where the
deductibility of property was subject to conditions subsequent that allowed
reentry. The Tax Court in Briggs interpreted the phrase “so remote as to
be negligible” to mean something that is highly improbable and “so remote as to
be lacking in reason and substance.” A did not show that the chance that
her gift would be rescinded was sufficiently remote to meet the standards
established in Briggs. Her estate and the insurance company
would be motivated by their own interests, not A's, and they would be
exercising valid rights created under state law. Furthermore, A,
herself, could endanger the gift if she stopped paying the premiums and the Charity did not
assume the liability.
The Service
in Ltr. Rul.
9110016 then addressed the gift tax issues in ruling requests 2-4. It
determined that A would not be allowed gift tax deductions for the
premium payments because she did not transfer her entire interest in the
property, and the gift might be revoked by her estate or the insurance
company. Furthermore, the interest A retained
in the policy was not susceptible to valuation. The rules described above
regarding remoteness and transfers of partial interests also applied to
prohibit a gift deduction.
Regarding a
charitable deduction by A's estate if she died within three years of
making the gift, under Sections
2035(a) , 2035(d)(1) and (2) and 2042(2)
,
A was correct that the proceeds of the policy would be included in her
estate. The proceeds would also be included in A's estate after the
three-year period if A's estate could recover the proceeds.
In either
case, A's estate could not take a charitable deduction for the proceeds
because the proceeds would not be going to the Charity. If the estate could not or
does not recover the proceeds and they pass to the Charity, the
estate still cannot take a charitable deduction under Section
2055(a) because the proceeds will pass due to the action or inaction of A's
executor and not directly from A.
This ruling
has serious consequences for charitable organizations and their donors. A
number of people use life
insurance
policies as a vehicle for making a large charitable contribution to an
organization. The policy is usually for a much higher amount than the donor
could contribute outright, which helps the charity and the donor. The donor
also can take an annual deduction for the initial and subsequent premiums paid.
The Service's
ruling puts such contributions in jeopardy. Though the ruling's application is
limited to the person who requested the ruling, it is an indication of the
Service's position on this issue and how it would respond to other taxpayers
who raise these questions. It also puts charitable organizations, donors, and
their professional advisors on notice that statutes such as Section 3205(b)(2) of the
The letter
ruling request has a certain bizarre quality, inviting the reader to inquire
why under these facts anyone would ask for a ruling. The Service appears overly
eager to accept this situation and stretched hard to analogize the instant
facts to prior law. The Service's idea of similar situations is uncommonly
elastic and quite possibly wrong.
As expected,
charitable organizations and insurance purveyors who are in a state of
agitation and awe are coming forward to defend this type of charitable giving.
Currently, 13 states allow charities to own or hold insurance
policies on the lives
of donors. 9 It is expected that
similar laws will soon be found in other states. State legislatures may see the
benefit of such legislation. It is hoped that the Service is not beginning a
campaign to challenge estates of donors who have made such contributions.
There are a
number of people who want to help the less fortunate, but who do not have the
financial means to make a significant cash
contribution. Contributing an insurance policy on her life is a way for
a donor to make such a contribution without significantly reducing the size of
the estate that passes to her heirs. Considering that the Federal and state governments
have not been able to meet the demand for public benefits and services, and
that the extra burden is falling on private donors, it seems that governmental
entities should be doing all they can to encourage and facilitate private
contributions, rather than discouraging donors.
See, e.g., Steinback v. Deipenbrock,
52 NE 662 ; Annotation, Validity of Assignment
of Life
Insurance
Policy to One Who Has No Insurable Interest in Insured, 30 A.L.R.2d 1310
(1953).
1976-1 CB 63, revoking Rev.
Rul. 6979, 1969-1 CB 63 .
See Rev.
Rul.
75-66, 1975-1 CB 85 .
1973-1 CB 117.
1977-1 CB 63.
Briggs,
72
TC 646 .
Gross, “IRS Ruling Raises Questions on Gifts of Insurance,” The
Chronicle of Philanthropy, pp. 17, 18 (4/9/91). The states are
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