IRS Stretched Too Far in Split-Insurance Estate Planning Case

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By Erin McManus

April 14 — The U.S. Tax Court provided another tool for estate planners and their clients to keep the family business in the hands of the family while lessening the tax consequences of a generational transfer.

Tax Court Judge Joseph Robert Goeke ruled April 13 in a division opinion that the premiums paid by a mother's trust for life insurance policies on her three sons in a split-life insurance arrangement weren't taxable gifts when he rejected as inapplicable Internal Revenue Service guidance and relied on the agency's own language in its rules (72 DTR K-3, 4/14/16).

Lawrence Brody, an estate planning partner at Bryan Cave in St. Louis, told Bloomberg BNA April 14 that Estate of Morrissette v. Commissioner, regarding an estate-planning transaction for the heirs to the Interstate Van Lines Inc. business, was a “fabulous decision that knocked down an argument that was a stretch by the IRS.”

‘Hideously Complex' Rules

The IRS wanted to treat nearly $30 million in life insurance premiums paid up front by Clara M. Morrissette's revocable trust for policies on the lives of her three sons as a gift even though a preamble—cited by Goeke—in the agency's own rules described the transaction as one in which Clara's trust would be the deemed owner of the policies.

Austin Bramwell, an estate planning partner at Milbank, Tweed, Hadley & McCloy LLP in New York, described the IRS's rules regarding the valuation of split-life insurance arrangements as “long and hideously complex.” Bramwell made his comments in an April 14 telephone interview with Bloomberg BNA.

Goeke found that the trusts that nominally held the policies received only the economic benefit of current life insurance protection. The premiums weren't a loan subject to gift tax upon Clara's death, because Clara's trust was to receive the greater of the aggregate premiums paid or the cash surrender value of the contract, foreclosing the possibility that one of the sons' trusts would receive an additional economic benefit.

Estate Tax

Brody said counsel for Clara's estate, James E. McNair III and Kelley C. Miller of Reed Smith LLP in Falls Church, Va., “were very smart in going after just the legal argument” that Clara's trust had the economic benefit of the premiums so the payments couldn't be considered a gift.

Eric Wang, also of Reed Smith in Falls Church, assisted McNair and Miller in the case. Wang told Bloomberg BNA in an April 14 interview that the amount of the estate tax on Clara's contractual right was still on the table. An April 14 e-mail from a Reed Smith representative estimated the present value of the premium payments for estate tax purposes at $7 million.

Bramwell noted that “the IRS was not amused” with this type of transaction when the agency first discovered its use. “Clara put in $30 million and got back $7 million. That $30 million was magically reduced to $7 million,” he said.

Going Forward

Brody said, “I know of at least half a dozen of these inter-generational arrangements where the IRS argued that because a single premium was paid up front, there were benefits to the younger generation's trust other than current life insurance protection. That forces the arrangement into the loan regime and gift tax liability.”

Brody said “the case was the very first ruling on these inter-generational split-dollar arrangements, so it’s very welcome. People thought it was a tossup on how it would come out. The IRS based its argument on”Notice 2002-59, which applied to certain abusive arrangements.

The court found the Morrissette trusts bore “no resemblance to the transactions” the notice was prohibiting. “The IRS must be very disappointed,” Brody said.

When asked if the case provided a road map, Wang said, “the facts would have to be very similar.”

Bramwell said “the arrangement isn't widely used, and it's clearly used by only very wealthy families. The IRS may try to come up with some form over substance arguments.”

To contact the reporter on this story: Erin McManus in Washington at

To contact the editor responsible for this story: Brett Ferguson at