Rev. Rul. 76-261

Advice has been requested whether, under the circumstances described below, the insured-decedent possessed sufficient incidents of ownership in an insurance policy held in a fiduciary capacity to require inclusion of the policy proceeds in the gross estate under section 2042 of the Internal Revenue Code of 1954.

In 1957 the decedent, H, purchased an insurance policy on decedent's life. Decedent's spouse, W, was named beneficiary. In 1962 H transferred complete ownership of the policy to W and added the names of their children as beneficiaries. In 1971 W died. In W's will, H was named executor of W's estate and trustee of a residuary trust established for the benefit of their children. The insurance policy on H's life was included in W's residuary estate.

H, as trustee, was granted absolute and unfettered discretion to distribute the current income from the trust to the beneficiaries or accumulate the income and add it to corpus. In addition, H, as trustee, was empowered in the management and investment of the trust property to do any and all things that a natural person, free from disability of every kind, might legally do with or in respect of such person's own property. Under the terms of the policy, the owner could elect to have the proceeds made payable according to various plans, use the loan value to pay the premiums, borrow on the policy, assign or pledge the policy, and elect to receive the annual dividends.

In 1974, H died and a successor trustee was named.

Section 2042(2) of the Code provides, in pertinent part, as follows:

The value of the gross estate shall include the value of all property--

* * * * *

(2) RECEIVABLE BY OTHER BENEFICIARIES.--To the extent of the amount receivable * * * as insurance under policies on the life of the decedent with respect to which the decedent possessed at his death any of the incidents of ownership, exercisable either alone or in conjunction with any other person.

Section 20.2042-1(c)(2) of the Estate Tax Regulations provides that:

For purposes of this paragraph, the term "incidents of ownership" is not limited in its meaning to ownership of the policy in the technical legal sense. Generally speaking, the term has reference to the right of the insured or his estate to the economic benefits of the policy. Thus, it includes the power to change the beneficiary, to surrender or cancel the policy, to assign the policy, to revoke an assignment, to pledge the policy for a loan, or to obtain from the insurer a loan against the surrender value of the policy, etc.

Section 20.2042-1(c)(4) of the regulations provides:

A decedent is considered to have an "incident of ownership" in an insurance policy on his life held in trust if, under the terms of the policy, the decedent (either alone or in conjunction with another person or persons) has the power (as trustee or otherwise) to change the beneficial ownership in the policy or its proceeds, or the time or manner of enjoyment thereof, even though the decedent has no beneficial interest in the trust.

In enacting section 811(g) of the Internal Revenue Code of 1939 (the predecessor of section 2042(2) of the 1954 Code), Congress introduced, but failed to define, the term "incidents of ownership." However, the Senate Finance Committee listed in its report the types of powers and interests that Congress meant to be included within the scope of the term. S. Rep. No. 1631, 77th Cong., 2d Sess. 235 (1942), 1942-2 C.B. 677. The powers and interests there listed are virtually the same as those now included in section 20.2042-1(c)(2) of the regulations.

At the time of the enactment of section 2042 of the Code, the Senate Finance Committee strongly inferred that Congress intended section 2042 to parallel the statutory scheme governing the interests and powers that will cause other types of property to be included in a decedent's estate under other Code sections, particularly sections 2036 and 2038. S. Rep. No. 1622, 83rd Cong., 2d Sess. 124 (1954). Under these sections, it is the decedent's power at the time of death to affect the beneficial interest or enjoyment of the property, or the income therefrom, that requires inclusion, even though the decedent had no right to receive any of the economic benefits.

That Congress had such an intent was recognized by the courts in Skifter v. Commissioner, 468 F. 2d 699 (2d Cir. 1972), a case involving an insured decedent's possession of certain incidents of ownership in a fiduciary capacity, and in Lumpkin v. Commissioner, 474 F. 2d 1092 (5th Cir. 1973), a case involving a decedent's incidents of ownership not held in a fiduciary capacity.

The court stated in Lumpkin that "by using the 'incidents of ownership' term Congress was attempting to tax the value of life insurance proceeds over which the insured at death still possessed a substantial degree of control." Then, drawing upon cases decided under the predecessors of sections 2036 and 2038 of the Code, the court concluded that the decedent possessed "substantial control" over the time and manner of enjoyment of the proceeds because of the right conferred upon him to elect optional modes of settlement (his only right) under a group term life insurance policy. The court held this right to be an incident of ownership within the meaning of section 2042(2) despite the fact that the decedent could not benefit himself or his estate. See Rose v. United States, 511 F. 2d 259 (5th Cir. 1975); United States v. Rhode Island Hospital Trust Company, 355 F. 2d 7 (1st Cir. 1966).

Further, the fact that a decedent's control over the insurance is subject to fiduciary restraints over its exercise does not automatically deprive it of the substantiality required for inclusion of the value of the proceeds in the gross estate. Section 20.2042-1(c)(4) of the regulations specifically provides that a decedent is considered to have an "incident of ownership" in a policy held in trust if the decedent has the power (as trustee or otherwise) to change the time or manner of enjoyment, even though the decedent has no beneficial interest in the trust.

In Skifter, the Court of Appeals for the Second Circuit concluded that section 20.2042-1(c)(4) of the regulations must be read to apply only to reservations of powers by the transferor as trustee. The Service will not follow this holding nor the dictum to the same effect in Fruehauf v. Commissioner, 427 F. 2d 80 (6th Cir. 1970). However, in Lumpkin, the Court of Appeals for the Fifth Circuit, in holding that the value of insurance proceeds was includible in the gross estate, stated that "it is enough if at death the decedent merely possessed an incident of ownership, the means by which he came into possessing being irrelevant." The principle of Lumpkin was again applied in Rose, another case involving incidents of ownership held in a fiduciary capacity, where the court pointed out:

* * * Under section 2036 Congress specifically levied the estate tax upon interests retained by a decedent in connection with an incomplete transfer; and section 2038 is similar in effect. Under section 2042, however, Congress applied the tax to insurance over which a decedent possessed any incidents of ownership. The difference in statutory language is significant. * * * We agree with the Second Circuit that section 2042 "roughly parallels" its cousin sections of the Estate Tax Code in regard to the substantiality of the decedent's control which is prerequisite to includibility in decedent's gross estate. But we cannot ignore Congress' conspicuous variety in statutory idiom, so as to make the tax treatment of insurance identical with the taxation of other interests: section 2042 was not drawn in terms to catch only retained incidents of ownership, and we find no basis to infer such a design. * * *

Similarly, the court in Terriberry v. United States, 517 F. 2d 286 (5th Cir. 1975), cert. denied, 44 U.S.L.W. 3530 (Mar. 22, 1976), held that the insurance proceeds on the decedent's life were includible in the decedent's gross estate under section 2042 of the Code where the decedent's wife transferred the policies to a revocable trust of which the decedent was a co-trustee.

In the instant case, the decedent, as trustee, through the right to elect optional modes of settlement, borrow on the policy, and withdraw dividends pursuant to the terms of the trust and the insurance policy, had a substantial degree of control over the time and enjoyment of the policy proceeds. Such control was an incident of ownership within the meaning of section 2042(2) of the Code.

Accordingly, since the insured-decedent possessed an incident of ownership in the insurance policy at the time of death, the proceeds of such insurance are includible in decedent's gross estate, even though held only in a fiduciary capacity.