In Personal Letter Ruling 201919002 (launched Might 10, 2019), the Inside Income Service thought of the provisions of an irrevocable life insurance coverage belief (ILIT), which had been modified pursuant to state statute earlier than the ILIT held any insurance coverage, in ruling that the ILIT’s subsequent buy of a coverage insuring the lifetime of the settlor’s little one would not give rise to any incidents of possession triggering inclusion within the beneficiary-child’s gross property below Inside Income Code Part 2042(2), offered that: (1) the beneficiary-child wasn’t serving because the trustee vested with all insurance-related powers on his dying (insurance coverage trustee); and (2) the ILIT instrument wasn’t subsequently modified in any manner that might trigger the beneficiary-child to regain any incidents of possession over the coverage.
The ruling serves as a practitioners’ reminder to stay aware of the potential for inadvertently-created incidents of possession each time drafting an irrevocable belief that is perhaps used to carry life insurance coverage. The ruling additionally re-emphasizes the truth that even inadequately drafted trusts could also be fastened pursuant to belief modification procedures acknowledged below state regulation.
Incidents of Possession
Earlier than continuing additional, it could be useful to elucidate what “incidents of possession” are with respect to insurance policies of life insurance coverage held in belief. For functions of the ruling, one should solely know that IRC Part 2042(2) gives that if a decedent-insured possessed sure proscribed powers at dying with respect to any coverage insuring his life, then he’ll be deemed to have possessed an “incident of possession” that can set off the inclusion of that coverage’s proceeds inside his property for federal property tax functions. In related half, incidents of possession embody any powers to: (1) change the coverage beneficiary; (2) give up or cancel the coverage; (three) assign the coverage to a brand new proprietor; (four) revoke a coverage task; (four) pledge the coverage for a mortgage; or (5) get hold of an insurer’s mortgage in opposition to the coverage’s give up worth. These incidents of possession have been outlined and interpreted broadly and could also be deemed to exist whether or not a prohibited energy is exercisable alone or along side others.
Background/Pre-Modification
Earlier than he died, the beneficiary-child’s mother or father established an ILIT for the advantage of one among his kids (Little one 1) and such little one’s descendants. Beneath the ILIT instrument, Little one 1 was to function trustee of the ILIT throughout Little one 1’s lifetime; no co-trustee was named. As trustee and beneficiary, a number of provisions of the ILIT instrument (instrument) granted Little one 1 powers that would’ve been deemed to lead to a number of of the above-discussed incidents of possession; particularly:
to personal and purchase life insurance coverage and to pay premiums on insurance policies insuring the lifetime of any particular person in whom the ILIT or its beneficiaries might have an insurable curiosity (Part 2.1);
to have all rights, powers, choices, elections, privileges and different incidents of possession over all ILIT-owned insurance coverage insurance policies (Part 2.four);
to make use of all or any a part of the ILIT’s internet revenue or principal to pay the premiums and different prices due on all ILIT-owned insurance coverage insurance policies (Part 2.5);
to distribute the ILIT’s internet revenue and principal to Little one 1, as beneficiary, pursuant to an ascertainable customary (i.e. that's, as decided for his personal well being, training, upkeep and help) (Article three); and
to nominate the ILIT property at Little one 1’s dying amongst Little one 1’s descendants (energy of appointment (POA)) (Part 6.1).
Within the preliminary yr of administration, the trustee proposed to buy a second-to-die life insurance coverage coverage insuring the joint lives of Little one 1 and Little one 1’s partner (partner). Nonetheless, if that coverage was bought, then Little one 1’s POA over all ILIT property would’ve been deemed an incident of possession, and that might’ve triggered the inclusion of the coverage’s proceeds in Little one 1’s gross property below Part 2042(2). Fortunately, the coverage wasn’t bought in 12 months 1, and Little one 1 was given a while to pursue ILIT modification choices below state regulation.
ILIT Modification Course of
Pursuant to a state statute authorizing the modification of irrevocable trusts, as trustee of the ILIT, Little one 1 efficiently petitioned the relevant courtroom to switch the instrument’s phrases in order to: (1) eradicate Little one 1’s POA with respect to any coverage insuring Little one 1’s life (and the proceeds thereof); (2) add provisions for an “insurance coverage trustee” who would have sole authority over any insurance policies on Little one 1’s life that the ILIT aquired; and (three) require that premiums on any coverage insuring Little one 1’s life may solely be paid from principal (and never from taxable revenue, as decided below Subchapter J of the IRC).
Later that very same yr, the related courtroom permitted Little one 1’s petition for modification. Particularly, the courtroom permitted and confirmed that the instrument was modified within the following methods: (1) Part 2.5 was modified in order that if the ILIT owned any coverage insuring the lifetime of the settlor, a beneficiary or a trustee of the ILIT, then premium funds may solely be constructed from principal (and never from taxable revenue);(2) Part 6.1 was modified to supply that the holder of any POA couldn’t train that energy with respect to any coverage insuring the powerholder’s life (or any proceeds therefrom); and (three) Little one 1’s sibling (Little one 2) was appointed because the insurance coverage trustee, an idea that was fleshed out in new Part 7.12(a). The insurance coverage trustee was basically a restricted goal third-party trustee who would train all fiduciary powers associated to any ILIT-held insurance coverage—this successfully eradicated the issues that existed below Sections 2.1, 2.four and Article III of the instrument earlier than its modification was accomplished.
Coverage Buy and Ruling
The IRS agreed that the modifications to the instrument eradicated the property inclusion publicity that might’ve in any other case existed below Part 2042(2). As insurance coverage trustee for the ILIT, Little one 2 bought a second-to-die coverage on the lives of Little one 1 and partner (coverage) within the yr following the courtroom’s ruling. In ruling that the acquisition wouldn’t set off inclusion below Part 2042(2), the IRS famous that the coverage wasn’t bought or held throughout the ILIT till in spite of everything potential “incident-of-ownership” sources had been eradicated from the instrument below relevant state regulation. Accordingly, based mostly on the info submitted and representations made earlier than it, the IRS concluded that Little one 1 didn’t, and wouldn’t, possess any incidents of possession over any coverage insuring Little one 1’s life that was acquired by the ILIT, as amended and that the proceeds thereof wouldn’t be includible in Little one 1’s gross property below Part 2042(2).
Stephen Putnoki-Higgins is an legal professional within the non-public shopper providers follow group at Shutts & Bowen LLP, in Tampa, Fla. and is admitted to follow in Connecticut, Florida, and New York.
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