IRC Section 6166 and Life Insurance

The scene is familiar one. The client, seated at the head of his large conference room table, is the sole owner of a successful business that comprises a significant portion of his taxable estate. Joining him around the table are his estate planning and corporate attorneys, audit and tax partners from his accounting firm and his life insurance agent. Also sitting in, and leaning very close to the conversation, are two senior members of the client’s executive team.

A Very Taxing Situation

The subject of the meeting is how to deal with, meaning pay, the very considerable estate tax that will be due when the client dies. You see, the client is a widower, so there’s no marital deduction to defer the tax to the death of a surviving spouse.

The client established an irrevocable life insurance trust (ILIT) some years ago. The ILIT owns a policy that’s nowhere near sufficient to cover the estate tax. The beneficiaries of the ILIT were originally his wife and two, now usually adult, children, neither of whom are involved in the business. If you listen carefully to the banter among the professionals at the table, you’d hear them describing the ILIT as a grantor trust for income tax purposes. You’d also hear them point out that the ILIT has the usual provision about providing liquidity to the estate by way of loans or purchases of assets.

Discussions with this client about estate tax planning have never been fruitful. He has steadfastly refused to do any planning that would result in his having anything less than complete control of the enterprise. Even the acronyms for the various planning strategies are now crying out from the slide decks, “Hey, enough. He’s just not into us! Never was and never will

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Make Sure Your Life Insurance Compliments Rather Than Complicates Your Estate Plan

Life insurance is a valuable tool to protect your family, and potentially your business interests after your death. Your estate plan is the collection of legal documents that include directions about what should happen to your assets upon your death. Your estate plan could include either a Last Will and Testament or a maybe a Living Trust. One of the most common problems I discover when I review existing planning with clients or potential clients is the failure to coordinate the outcome of a will or trust and the outcome of life insurance proceeds. Let’s examine some of the potential problems this can create so that we can avoid them.

First, I regularly find that clients have all of their children named as the beneficiaries of their estate through a will or trust if their spouse does not outlive them, but their life insurance policy does not list their children as back-up beneficiaries. Or, perhaps the policy only lists one of their several children as beneficiary. This could be done purposely (perhaps one child is meant to receive all of the life insurance proceeds but will not receive as much as the other children from the other assets of the estate). More often, however, the life insurance beneficiaries have been named without any thought or understanding about the bigger picture of how the rest of the estate will be divided. This can lead to one or more children receiving a much larger share of inheritance than the others (which is perfectly fine if that is your intent, but you don’t want this to happen just because of poor planning).

A nightmare scenario can occur in a blended family/second marriage situation where life insurance beneficiaries were never updated after a divorce, prior spouse’s death, or other life event changes. Whether or

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