Firm Seeks Exclusion From Reportable Policy Sale Definition

May 9, 2019

Acting Chief Counsel of the IRS, Michael J. Desmond
Deputy Chief Counsel (Technical), William M. Paul
Deputy Chief Counsel (Operations), Drita Tonuzi

Re: Comments on the Treatment of Trusts under Section 101

Dear Sir:

I am pleased to submit the enclosed comments on proposed regulations to section 101 of the Internal Revenue Code of 1986, as amended, which was amended by sections 13520 and 13522 of “[a]n Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution of the budget for fiscal year 2018” Pub. L. 115-97, 131 Stat. 2054, 2149 (Act). I respectfully request clarification with regard to the treatment of trusts under section 101.

I am an attorney licensed to practice law in Georgia and Florida and a fellow of the American College of Trust and Estate Counsel. My law practice focuses primarily on estate and tax planning for high net worth individuals.

If you or your staff would like to discuss my comments, please contact me at (404) 873-8790 or by email at Michael.VanCise@agg.com.

Respectfully submitted,

ARNALL GOLDEN GREGORY LLP

Michael L. Van Cise
Arnall Golden Gregory LLP
Atlanta, GA

Enclosure:
Comments on the Treatment of Trusts under Section 101, May 9, 2019

Cc:
Steve Gorin, Esquire (via e-mail)

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COMMENTS ON THE TREATMENT OF TRUSTS UNDER SECTION 101

May 9, 2019

These comments address the proposed regulations that amend the regulations under section 101 of the Internal Revenue Code¹ that were published in the Federal Register on November 26, 1960 (25 Fed. Reg. 11402), as subsequently amended on December 25, 1964 (29 Fed. Reg. 18356), September 27, 1982 (47 Fed. Reg. 42337), and July 26, 2007 (72 Fed. Reg. 41159) (existing regulations).

I appreciate the opportunity to submit these comments on the treatment of trusts under section 101 for consideration by Treasury and the Internal Revenue Service. These comments focus on the operation of the rules and regulations under section 101(a)(3) that further narrow the exception to the transfer for value rules with the addition of the “reportable policy sale” limitation.

Background.

The proposed regulations implement recent legislative changes to section 101 and 6050Y by section 13520 and 13522 of “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” Pub. L 115-97, 131 Stat. 2054, 2149 (the “Act”). Section 13552 of the Act amended section 101. The new section 101(a)(3) defines the term “reportable policy sale” and provides rules for determining the amount of death benefits excluded from gross income following a reportable policy sale. The proposed regulations under section 101 provide definitions applicable under sections 101 and 6050Y.

Under section 101(a)(3), in order not to be a “reportable policy sale,” the acquirer of the interest in the life insurance contract, whether a direct or an indirect acquirer, must have a substantial family, business, or financial relationship with the insured apart from the acquirer's interest in the life insurance contract itself.

The proposed regulations under section 101 define substantial family, business, and financial relationships for purposes of determining whether a transfer constitutes a “reportable policy sale.”

Proposed Regulations Requiring Clarification.

Proposed treasury regulation section 1.101-1(d)(1) provides, in part, may

A substantial family relationship also exists between the insured and a partnership, trust, or other entity if all of the beneficial owners of that partnership, trust, or other entity have a substantial family relationship with the insured. For example, a substantial family relationship exists between the insured and an entity that acquires an interest in a life insurance contract on the insured's life if the insured is the sole beneficial owner of the entity or each beneficial owner of the entity is either the insured or a family member of the insured.

Proposed treasury regulation section 1.101-1(f)(3) defines a family member to be, in short, ancestors (up through great-grandparents), descendants of such ancestors, and spouses of any of the foregoing, and “any trust established and maintained for the primary benefit of the individual or one or more”² of the foregoing.

Proposed treasury regulation section 1.101-1(f)(1) further provides:

A beneficial owner of a partnership, trust, or other entity is an individual or C corporation with an interest in that entity. The interest may be held directly or indirectly, through one or more other partnerships, trusts, or other entities. For instance, an individual that directly owns an interest in a partnership (P1), which directly owns an interest in another partnership (P2), is an indirect beneficial owner of P2 and any assets or other entities owned by P2 directly or indirectly. For purposes of this paragraph (f)(1), the beneficial owners of a trust include those who may receive current distributions of trust income or corpus and those who could receive distributions if the trust were to terminate currently.

Proposed treasury regulation section 1.101-1(e)(3) provides, in part, that the acquisition of an interest in a life insurance contract may be direct or indirect. “[T]he transfer of an interest in a life insurance contract results in the direct acquisition of the interest by the transferee (acquirer).”³ “[A]n indirect acquisition of an interest in a life insurance contract occurs when a person (acquirer) becomes a beneficial owner of a partnership, trust, or other entity that holds (whether directly or indirectly) the interest in the life insurance contract.”⁴

Proposed treasury regulation section 1.101-1(d)(3)(iii) specifically contemplates charities in the context of “substantial financial relationship” by expressly providing that a substantial financial relationship will exist between the insured and the acquire where “[t]he acquirer is an organization described in sections 170(c), 2055(a), and 2522(a) that previously received financial support in a substantial amount or significant volunteer support from the insured.”

Combination of Family and Financial Relationship; Trusts with Family and Charitable Beneficiaries. Proposed treasury regulation section 1.101-1(d)(1) seems to require, in order for a trust, partnership, or entity to be considered to have a “substantial family relationship” with the insured, that “all of the beneficial owners” of such trust, partnership, or entity have a substantial family relationship with the insured. This means that if even one beneficiary of a trust is not a family member within the definition of proposed treasury regulation section 1.101-1(f)(3), then the trust will lack a substantial family relationship to the insured. Accordingly, a transfer to such a trust will be regarded as a reportable policy sale unless the beneficial owners of the trust have substantial business relationship or a substantial financial relationship with the insured.

This result seems overly restrictive and inconsistent with section 101(a)(3). Section 101(a)(3) provides that a reportable policy sale is an acquisition of an interest in a life insurance contract if the acquirer has “no substantial family, business or financial relationship with the insured apart from the acquirer's interest in such life insurance contract.” Accordingly, it seems that so long as all the beneficial owners of a trust have a substantial family, business or financial relationship to the insured, then a transfer to such a trust should not be a reportable policy sale within the meaning of section 101(a)(3).⁵

A series of examples helps illustrate this point. Assume the following facts:

Common Facts:

I is the initial policyholder of a $100,000 insurance policy on I's life. Partnership P is a valid state law partnership owned by I, S, and G. The capital and profits interest of Partnership P is owned as follows:

Example 1 (Transfer for value to charity that is a partner of the insured):

I transfers 10% of the capital and profits interest of Partnership P to charity C. Subsequent to the transfer of an interest in Partnership P by I to charity C, I transfers the insurance policy on I's life to charity C in exchange for a charitable gift annuity. The transfer of the life insurance contract is a transfer for valuable consideration, but because charity C is a partner of the insured an exception under section 101(a)(2)(B) is satisfied. Further, because charity C has a substantial financial relationship with I pursuant to proposed treasury regulation section 1.101-1(d)(3)(iii), the transfer is not a reportable policy sale.

Example 2 (Transfer to family-member trust that is a partner of the insured):

I creates Trust T which provides income to grandchild G until the earlier of grandchild G's death or 10 years from Trust T's creation at which time the trust terminates. Upon Trust T's termination, the corpus is paid to grandchild G, if living, and if not, then to I. I transfers 20% of the capital and profits interest of Partnership P to Trust T. Subsequent to such transfer of interests in Partnership P to Trust T, I sells the insurance policy on I's life for $6,000, its fair market value, to Trust T. The transfer of the life insurance contract is a transfer for valuable consideration, but because Trust T is a partner of the insured an exception under section 101(a)(2)(B) is satisfied. Further, because all of the beneficial owners of the trust have a substantial family relationship with I pursuant to proposed treasury regulation section 1.101-1(d)(1), the transfer is not a reportable policy sale.

Example 3 (Transfer to a trust with family members and charity holding beneficial interests):

I creates Trust T which provides income to grandchild G until the earlier of grandchild G's death or 10 years from Trust T's creation at which time the trust terminates. Upon Trust T's termination, the corpus is paid equally between charity C and grandchild G, provided that if grandchild G is not then living, then the corpus is paid entirely to charity C. I transfers 20% of the capital and profits interest of Partnership P to Trust T and 10% of the capital and profits interest of Partnership P to charity C such that the capital and profits interest of Partnership P is owned as follows:

Subsequent to such transfer of interests in Partnership P to Trust T and charity C, I sells the insurance policy on I's life for $6,000, its fair market value, to Trust T. The transfer of the life insurance contract is a transfer for valuable consideration, but because Trust T is a partner of the insured an exception under section 101(a)(2)(B) is satisfied. However, Trust T does not have a substantial family relationship with I because not all of the beneficial owners of the trust have a substantial family relationship with the insured.⁶

Accordingly, assuming the beneficial owners of the trust have no substantial financial or business relationship with I, I's sale of the policy to Trust T under the facts in example 3 above is a reportable policy sale (even though charity C has a substantial financial relationship and there would be no “reportable policy sale” if charity C were the direct acquirer of the policy).

Section 101(a)(3) provides that the acquisition of a policy is a reportable policy sale unless the acquirer has a “substantial family, business, or financial relationship with the insured apart from the acquirer's interest in such life insurance contract.” Given that the transfer for value in example 1 (to a charity which is a partner of the insured) is not a reportable policy sale (because of a substantial financial relationship) and the transfer for value in example 2 (to a trust with only family member beneficiaries) is not a reportable policy sale (because of a substantial family relationship), it seems that the transfer for value in example 3 (to a trust with family members and charity C as beneficiaries) should also not be a reportable policy sale. However, this seems not to be the case under the proposed regulations.

Because section 101(a)(3) is drafted with the disjunctive “or,”⁷ satisfaction of any of the three necessary relationships, family, business, or financial, excepts a transfer from a reportable policy sale. Accordingly, it seems reasonable to permit an entity (such as a trust) to acquire a policy and such acquisition not be a “reportable policy sale” so long as all the beneficial owners of the entity have either a substantial family, business, and/or financial relationship with the insured apart from the insurance policy.

Accordingly, the proposed regulations should be revised to exclude from the definition of a reportable policy sale a transfer to a trust where all the beneficiaries have either a substantial family, business or financial relationship. An alternative revision that would address the issue highlighted here is to include charities with which the insured has given substantial financial support or significant volunteer support within the definition of “family member” under proposed treasury regulation section 1-101(f)(3).