Value of split-dollar arrangement is not its cash surrender value

The Tax Court held that the value includible in a taxpayer’s gross estate for a receivable created under split-dollar life insurance arrangements was the stipulated value of the receivable created by the arrangements, not the much higher cash surrender value of the insurance policies purchased as part of the arrangements.

Facts: Marion Levine was born in 1920 in St. Paul, Minn., and, by the time she died in 2009, had a net worth in excess of $25 million. Her beneficiaries included her two children and five grandchildren.

In an initial estate planning move, Levine created a revocable trust (the Marion Levine Trust) in 1988. In 2007, Levine retained a new adviser to revise her estate plan. The adviser suggested the family consider an intergenerational split-dollar life insurance arrangement, with split-dollar life insurance policies purchased on the lives of Levine’s daughter, Nancy, and son-in-law, Larry.

As part of the arrangement, an irrevocable trust (the insurance trust) was created to buy and own the split-dollar insurance policies. The insurance trust was settled in South Dakota, and, under the terms of the trust and South Dakota law, the investments in the trust were controlled by the trust’s “investment committee.” The investment committee consisted of one person: Bob Larson (Levine’s longtime friend and business partner).

The insurance trust then bought two last-to-die insurance policies on the lives of Nancy and her husband. Levine’s revocable trust paid the premiums on those policies, which totaled $6.5 million. The insurance trust owned the life insurance policies.

Under the split-dollar arrangement, when the last surviving insured died or the insurance policies were terminated, the insurance trust was required to pay Levine’s revocable trust the greater of the premiums paid or the cash surrender value of the policies (the split-dollar receivable). Only Larson, as the insurance trust’s sole investment committee member, had the power to terminate the policies before both insureds died.

Levine’s estate tax return included the value of the split-dollar receivable, which it claimed was approximately $2 million. The IRS, noting the shift in money from the revocable trust to purchase insurance policies benefiting the insurance trust, opened an audit of the return.

The IRS determined that rather than including the value of the receivable, the estate should have included the $6.2 million cash surrender value of the life insurance policies purchased by the insurance trust. The IRS issued a notice of deficiency to the estate for just over $3 million, plus penalties. The estate challenged the IRS’s determination in Tax Court.

Issues: The Tax Court had to determine whether, as a result of the split-dollar life insurance arrangements, Levine’s estate was required to include the value of the split-dollar receivable or the current cash surrender value of the policies owned by the insurance trust.

The estate argued that the only asset from the arrangement owned by Levine’s revocable trust at the time of her death was the split-dollar receivable. According to the estate, Levine had no interest or ownership over the life insurance policies because those were owned by the insurance trust, and Larson was the only person with the power to terminate those policies. However, she had to wait for the deaths of both Nancy and her husband or the termination of the policies in order to receive the cash surrender value.

The IRS argued that at her death, under Sec. 2036, Levine retained the right to income, or the right to designate who would possess the income, from the split-dollar arrangement, and under Sec. 2038 she maintained the power to alter, amend, revoke, or terminate the enjoyment of aspects of the split-dollar arrangement. Thus, she was the owner of the policies at her death, and the cash surrender value of the policies should be included in her estate.

In the alternative, the IRS argued that the restrictions in the split-dollar arrangement should be disregarded under the special valuation rules provided in Sec. 2703 and, as a consequence, the estate was required to include in its taxable value the full cash surrender values of the policies.

Holding: The Tax Court held that, at the time of her death, Levine only held the right to the split-dollar receivable and that Secs. 2036(a)(2) and 2038 did not require inclusion of the policies’ cash surrender values because Levine “did not have any right, whether by herself or in conjunction with anyone else, to terminate the policies because only the irrevocable trust had that right.” Therefore, the estate was only required to include the value of the split-dollar receivable, which the IRS and the estate had stipulated to be $2.3 million.

The court held that Sec. 2703 does not apply to this case because the only property interest Levine had at the time of her death was the receivable, and there were no restrictions on that.

• Estate of Levine, 158 T.C. No. 2 (2022).

— Hannah Pitstick is a writer with the Association of International Certified Professional Accountants.