What Joint Term Life Insurance is All About

Sometimes Avoiding Taxes Creates More Taxes – Particularly Insurance Trusts and GST’s

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When Doing Your Estate Planning, Sometimes NOT Having A Tax Actually Creates a Problem for Taxpayers:

Insurance Trusts and Generation Skipping Taxes in 2010

No Generation Skipping Taxes:

Since January and through the end of December of 2010, there is no Generation Skipping Transfer (GST) Tax, unless Congress changes the law in the meantime. The GST tax was part of the temporary repeal for one year of the estate tax, which automatically expires at the end of 2010. Starting January 1, 2011, the estate tax and the GST tax come back in full fury with up to a 55% rate of tax. Your estate can suffer both an estate tax and a GST tax at 55% each.

Insurance Trusts:

Trusts which own life insurance are one of the most efficient ways to avoid estate and GST taxes. Over the lifetime of the life insurance policy, the taxpayer may pay $300,000 in premiums, but the taxpayer’s heirs receive $1,000,000 of the death benefit of the life insurance tax free if the insurance is owned by an Irrevocable Life Insurance Trust. If the taxpayer still owns or controls the life insurance (not owned by an independent trust), then the taxpayer may have to pay estate and GST taxes at rates up to 55% on the $1,000,000 in 2011 and thereafter. People are often confused by this because there is no capital gain tax on the difference between the $300,000 paid for the policy and the $1,000,000 death benefit to the heirs. But, there is an estate tax on life insurance proceeds you own which is not in a trust even though there is no capital gains tax on the “profit”.

Creating the Insurance Trust:

Fred creates a life insurance trust, transfers the initial premium payments to the trustee of the trust (his CPA) and the CPA as trustee purchases the life insurance policy on behalf of the trust. The result is that when Fred dies, the $1,000,000 death benefit is available to Fred’s heirs with no estate taxes. If the life insurance trust creates lifetime trusts for Fred’s two children, Ellen and Paul, then Ellen and Paul split the $1,000,000 in their lifetime trusts and Ellen and Paul pay no estate taxes in their estates on the life insurance proceeds. Fred loves his grandchildren and sets up this life insurance trust to say that when Ellen and Paul die, then the grandchildren can also receive the remaining money in the insurance trust without any estate taxes. This can go on for generations and create a “Dynasty Trust”.

Annual Gifts of Premiums:


Each year Fred sends the annual premium of $20,000 to Fred’s CPA and the CPA pays the $20,000 for the annual premium payments for the insurance owned by the trust. Each year, the CPA sends a notice to Ellen of her right to take out $10,000 each year for 30 days and sends the same notice to Paul for his $10,000. Each year, Ellen and Paul do not ask for their respective $10,000. As a result, if proper procedures are followed, the $20,000 paid each year is exempt from gift taxes (which could be due from Fred) and if Fred’s total gifts per year are less than the annual exemption per person, $13,000 this year, then there is no gift tax paid on the $20,000 and no decrease in the $1,000,000 gift tax exemption of Fred.

Generation Skipping Trust Gifts:

If Ellen has the ability to unilaterally decide when she dies who gets her accumulated annual $10,000 gifts to the insurance trust, then all of the $10,000 gifts are part of her taxable estate as well as her $500,000, her 50% share of the $1,000,000 life insurance death benefit. We want the benefit of excluding this $500,000 from the estate of Fred and also from the estate of Ellen. So, we do not give Ellen the right unilaterally to decide who may get her accumulated $10,000 annual premium payments. When we do this, two things occur: (1) It is not part of Ellen’s taxable estate and (2) the $10,000 annual gift for the benefit of Ellen to the insurance trust does not qualify as a gift exempt from GST taxes. Unless we do something, the $1,000,000 death benefit could be subject to the 55% GST tax. What normally is done is that the CPA files a gift tax return each year using $20,000 of Fred’s exemption from the GST tax. This is a highly leveraged beneficial use of the GST tax exemption. Many insurance trusts are set up this way.

No Tax, No Exemption:

In 2010, there is no GST tax and therefore no exemption from GST tax. In 2010, the CPA can not file a paper with the IRS claiming a $20,000 exemption from GST tax. Does this mean that part or all of the death benefits are in the taxable estate of Ellen or Paul or is subject to GST tax in the estate of Fred? For all of those who have such insurance trusts, it is necessary that you take action quickly to solve this problem.

Loan the Premium:

The solution that many advisors are recommending is that instead of gifting the $20,000 in 2010, Fred should loan the $20,000 to the CPA in 2010 to avoid this problem. The insurance trust, not the CPA, is the borrower. In future years, the loan can be paid back to Fred either from additional gifts by Fred to the trust or a loan from the insurance policy.

Action Necessary if You Have an Insurance Trust:

If you have an insurance trust, be sure to analyze whether your trust has this problem in 2010. If so, I strongly suggest you seek the help of a seasoned Estate Planning Attorney as soon as possible.

Source https://ezinearticles.com/?Sometimes-Avoiding-Taxes-Creates-More-Taxes—Particularly-Insurance-Trusts-and-GSTs&id=4639833


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