Insurance Planning: Taxation of Insurance (Module 12)

Transfer of Value Example: Assume that a mother is the owner and insured on a policy with a death benefit of $400k, a yearly premium of $7300 and a cash value of $75k. The mother sells this policy to her daughter (the beneficiary) for the $75k cash value. When the mom dies three years later, what is the tax consequences for the daughter?

$303,100 taxed at her marginal tax rate Her cost basis includes the $75k she paid for it plus the three years of premiums that equaled $21900. For a total of $96900. Subtract that from the $400k death benefit she received.

Gift tax: what is the annual limits and lifetime limits?

- Annual is $15k. Any gift in an calandar year at or less than $15k is not taxed - Lifetime limit is $11,180,000.00, By limit we mean that you cannot send that much of a taxable gift in a lifetime to one person. The key is taxable. If the gifts are less then $15k a year then that doesnt count towards the limit

In regards to the transfer of value tax rule, what individuals or entities could the policies be transferred to to be exempt?

- the insured - the insureds partner - the transferor's spouse incident to a divorce - a new owner who takes the transfereros basis in the contract - to a partnership in which the insured is a partner - to a corporation in which the insured is a shareholder or officer

Accelerated Death Benefits will be considered tax-free if the following three parts are met:

- the insured must be terminally ill - the reduction of the remaining face value of coverage is limited - the cash value of the remaining death benefit may not be reduced

Bob is a key employee of BB, Inc. Bob is retiring, and the company says they will sell the key man policy on Bob. Who can purchase the policy and not trigger a transfer-for-value problem? a. Bob b. Bob's life insurance trust c. Bob's children d. Bob's wife

A Only Bob, the insured, can purchase the policy. The other answers can trigger transfer-for-value.

Premiums paid by an insured are gifts if the insured: a. Does not own the policy and proceeds of the policy are payable to a beneficiary other than his estate. b. Owns the policy but proceeds of the policy are not payable to his estate. c. Does not own the policy but proceeds of the policy are payable to his estate. d. Owns the policy but wishes to pass on the proceeds of the policy to some charity.

A Premiums paid by an insured are gifts if the insured has no incidents of ownership in the policy and proceeds of the policy are payable to a beneficiary other than his or her estate. Premiums paid by a beneficiary on a policy that he or she owns are not gifts.

Mr. Ball worked for ABC, Inc. ABC, Inc. had no group life insurance plan but paid Mrs. Ball $40,000 upon the death of her husband. What is the tax effect to Mrs. Ball? a. The $40,000 is taxable as ordinary income. b. The $40,000 is tax-free. c. $35,000 is taxable; $5,000 is a de minimus payment.

A The $5,000 exclusion rule (de minimus payment) was eliminated. The only way the company can pay $40,000 to Mrs. Ball is to charge her with income.

Assume John names his son Fred as beneficiary of his $1 million life insurance policy, and transfers the policy to him six years before his death. If John retained the right to change the beneficiary, the $1 million death benefit will be included in which estate? a. John's b. Fred's c. Neither estate

A Because he retained an incidents of ownership

Generation Skipping Transfer Tax

A tax on wealth and property transfers to a person 2 or more generations younger than the donor. Assets are taxed as if they moved from the grandparents to their own children, then from children to the grandchildren.

If Frank had purchased a $500,000 policy on Howie with a single premium (MEC policy) and Howie died, how would the death benefits be treated? a. They'd be subject to income tax plus a 10% penalty. b. They'd be tax-free. c. They'd be subject to income tax.

B Death benefits from MEC contracts are tax-free. Living benefits are subject to MEC rules.

The federal gift tax is incurred if: a. If a mother gifts her son a watch worth $9,000, in a specific year. b. If a mother gifts her daughter a watch worth $16,000, in a specific year. c. If one sends a Christmas card worth $2 to a friend for Christmas. d. A mother gifts a teddy bear worth $10 to her son on his birthday.

B The federal gift tax law is not aimed at the usual exchange of gifts associated with birthdays, holidays and similar occasions. The law permits a donor to make a gift without tax by excluding the first $13,000 of outright gifts in any one specific year to any one recipient.

Silvia Taylor, a widow, is approaching retirement. Her husband died a few years ago and besides inheriting his whole estate she received the proceeds of his life policy of $500,000. Uncertain of what to do, she left the $500,000 with the insurance company under interest settlement option (like a savings account). Now she would like to place the $500,000 with a money manager. What will the taxation situation on the $500,000 be? a. She will not be able to request a lump sum payment because she elected a settlement option. b. The $500,000 will be subject to a 10% penalty. c. The $500,000 will be paid tax-free. d. The gain over basis will be subject to ordinary income.

C He died, the $500,000 is income tax-free. His basis is immaterial. The interest settlement option gives her complete flexibility. NOTE: Interest paid on the $500,000 will be taxable.

Sam purchased a $100,000 whole life policy in 1985. He deposited $50,000 in a single premium. Today, the policy has a cash value of $90,000 and a death benefit of $130,000. Which of the following are true? a. The excess $30,000 of death benefits will be income taxable if he dies. b. If he borrows $40,000, he will have to pay income tax on the loan. c. There is no deferral on the increase in cash value because the policy is violating the cash value accumulation test. d. If he cashes in the policy, he will have to declare the $40,000 as income. e. If he withdraws $40,000, he will have to pay income tax on the withdrawal.

D The policy was purchased before 1988. The MEC rules do not apply.

Gale and Susan started a business many years ago. They did a regular C Corporation and did an entity purchase buy-sell funded with life insurance. Gale has decided to leave and do something different. She is going to sell her stock to Susan. Gale would like to purchase her policy from the corporation for personal use. If the corporation sells the policy to Gale for its value, how can Gale avoid triggering a transfer-for-value? a. Susan should buy Gale's policy and then Susan should gift it to Gale to avoid transfer-for-value. b. Gale's husband should purchase the policy to avoid transfer-for-value. c. The policy should be returned to the insurance carrier and a new policy with Gale as owner will be issued. This would avoid transfer-for-value. d. Gale should purchase the policy to avoid transfer-for- value.

D The simplest solution is that the insured can buy her policy. It will never create a transfer-for-value problem. If someone other than Gale purchases the policy, it will create transfer-for-value. Gale can buy her policy and not create a problem. That the policy should be returned to the insurance carrier and a new policy with Gale as owner will be issued, because this would avoid transfer-for-value is a crazy answer. You cannot do that.

In regards to an individually purchased life insurance policy, how does it effect estate taxes?

If the insured is also the owner then the death proceeds are included int heir gross estate and may be subject to estate taxes depending on if the face amount puts his estate over the exempt amount limit

How can irrevocable trusts help with estate taxes from life insurance proceeds?

If the policy is put into an irrevocable trust over three years before the death then the proceeds will not be counted towards the deceased estate

Applicable Credit or Unified Credit

Is a tax credit that can be applied to offset estate and gift taxes.

Adjusted Gross Estate

Is the gross estate value minus funeral and administrative expenses, debts and taxes, and casualty losses. From the adjusted gross estate the dependents marital deduction, charitable deduction and state death tax deduction are applied to determine the tentative estate tax

How does estate taxes with life insurance proceeds work if the insured/owner has his wife is the beneficiary?

It is counted towards his estate but since she would qualify for the unlimited estate tax marital deduction then no estate taxes would have to be paid

Jan owns a insurance on her husband's life, with their children named as revocable beneficiaries. When her husband dies and the proceeds go to the kids, what are the gift tax consequences?

Jan will be deemed to have made a gift to the children in the full amount of the proceeds when they are paid at her husband's death. It is assumed that there is no intent to make a gift in the literal sense, but a taxable gift has been made nevertheless.

In general on an individually purchased life insurance policy, how are the premiums & death proceeds taxed?

The premiums are NOT tax deductible. The death proceeds are federally tax free

Don and Bill own a business valued at $1,000,000. Some years ago, they signed a cross-purchase agreement using life insurance. Don is leaving to start a new business. Don wants to purchase his life insurance policy ($250,000) from Bill. Which of the following triggers a transfer for value problem? a. A direct transfer for value the policy from Bill to Don's wife to avoid the three-year estate inclusion rule. b. A transfer for value of the policy from Bill to Don. c. A sale of the policy from Bill to the new business (corporation) that Don is starting. d. A sale of the policy from Bill to Don.

a The exceptions are a sale or transfer to the insured (Don) or a sale to a corporation in which the insured is a shareholder or officer.

Robert Brown is married. He has a wife, Sarah, and a daughter, Jenny. He buys a policy in his name, and insures his wife and names his daughter as a beneficiary. At Sarah's death, Jenny receives the life insurance death proceeds as a gift from Robert. a. True b. False

A Gifts occur when one person owns a policy, a second is insured, and the third is a beneficiary. Life insurance policies are not gifts under ordinary circumstances. A gift usually occurs from a policy owner to the beneficiary at the insured's death.

Generally, a federal estate tax return must be filed and any estate taxes paid within _______ months of the death of any US citizen or resident who leaves a gross estate of more than a specified exempted amount. The exempted amount in 2018 is $______________

Nine; $11,180,000

How does gift tax effect life insurance policies that are gifted to individuals?

They are considered gifts of present interest, since the new owner can keep the policy, sell it or gift it to someone else. The annual exclusion up to $15k applies.

How is the withdrawal of the cash value in a life insurance contract taxed?

if the insured withdraws the savings value of the insurance and if this value exceeds the insured's adjusted basis, (premiums paid less dividends received), the excess is subject to federal income tax in the year of the withdrawal

If a person owns a life insurance policy on another persons life, how does that effect estate taxes?

only the replacement cost of the policy at the time of the owner's death is included in his or her estate

Alternative Valuation Date

the administrator may choose an alternative date to the date of death for the valuation of the decedent's estate for federal estate tax purposes. It would be six months after date of death

Present of Interest

the annual exclusion is available only when the gift is one of a present interest. This is a situation in which the recipient must have possession or enjoyment of the property immediately. An example is a gift of cash or property that can be used immediately by the recipient