| Take a Moment to Contact Gonnella & Majors, PC |
Irrevocable Life Insurance Trust (ILIT)
equally effective for second-to-die life insurance policies. The ILIT is created by the estate planning attorney and designed in accordance with the clients’ goals for the use of the insurance proceeds.
trust retains no control over the trust or its contents, when administered correctly, the entire value of the contents of the trust (life insurance proceeds) are not counted in the taxable estate of the creator when he or she dies.
The insured is generally the creator, Trustor/Grantor, of the ILIT. The insured determines who benefits from the ILIT and under what terms the beneficiaries receive benefits. Naturally, the insured is the person whose life is covered by any insurance policies owned by the Trust. (b) Trustee The Trustee is the person designated to administer the ILIT. The Trustee pays insurance premiums, collects the proceeds when the insured dies and distributes money to the beneficiaries in accordance with the terms of the ILIT. The Trustee may be a professional trustee, the family attorney, CPA or a family member. The spouse of the insured may be the Trustee, but it is important that none of the money contributed to the ILIT belongs (under state law or otherwise) to the spouse and that the policy is not a second-to-die policy. If the spouse owns any of the money contributed to the ILIT, a proportionate share of the insurance proceeds will be included in the spouse’s estate if the spouse is also a beneficiary of the ILIT. (c) Beneficiaries Beneficiaries are the persons who will ultimately receive benefits from the ILIT according to the terms the Grantor established. Usually, there are two occasions when benefits are available to the beneficiaries.
at least equal to the premium of any life insurance policy held by the trust), each of the beneficiaries has the power to withdraw his or her own proportionate share of the contributed amount. Usually the power to withdraw must be exercised within a specific limited time frame. If the beneficiary exercises the demand, the Trustee must distribute the beneficiary’s proportionate amount of the contributed money. If the beneficiary does not, then after the withdrawal period expires, the Trustee pays the insurance premium. (This is called a “Crummey Power”, named after the tax case in which this issue was resolved.) Second, when the insured dies, the life insurance proceeds pay into the trust and are managed and administered for the benefit of the beneficiaries as directed by the trust agreement. Depending on the trust’s provisions, distributions may be made immediately, may be held for a certain period of time, or held for generations . What are the special requirements of a generation-skipping trust?
may cause the trust to become a generation skipping trust. As an example, if a child dies and a grandchild becomes the beneficiary of the deceased child’s share, a generation skipping tax would be due on payments to the grandchild. To prevent that, a portion of the insured’s Generation Skipping Tax Exemption is allocated to the ILIT by filing a Form 709 Federal Gift and Generation Skipping Transfer Tax Return with the IRS. If the non-gifting spouse has agreed to gift split, that spouse must allocate that spouse’s GST to the ILIT. In either case, the allocation is in an amount equal to the premiums. The child may also be given a general power of appointment and GST Exemption does not need to be allocated. What is the cash flow arrangement in an ILIT? As we alluded above, the insured contributes at least enough money to the ILIT to pay the premium on the life insurance policy. The Trustee holds the funds during the withdrawal period and then makes the premium payments. It is important that the insured contribute the funds to the ILIT so that the formalities of the ILIT are followed. If the ILIT terms are not followed, the Internal Revenue Service may attempt to disregard the ILIT and include the insurance proceeds in the insured’s estate or disallow the premiums from qualifying for the annual gift tax exclusion. As cash value builds up in the ILIT, it can be available to the spouse beneficiary for his or her health, education, maintenance or support (if the trust so provides). When the insured dies, the trustee collects the proceeds and then administers and distributes them according to the terms of the ILIT. Are the premium contributions to the ILIT a taxable gift by the insured?
Revenue Code section 2503(b) to any other person and the gift is excluded from taxable gifts – presently $11,000 per year, per donee. That means spouses may contribute double the applicable amount per child. If only one spouse is making the gift/insurance premium contributions, the other spouse can agree to “gift split.” Gift splitting means that the other spouse enables the gifting spouse to contribute up to double the relevant amount to the Trust for non-spouse beneficiaries and use the other spouse’s exclusion per child exclusion. Does that work for gifts to a trust? In general, no, as but discussed above, using a Crummey demand right qualifies the contributed gift for treatment as a present interest gift for purposes of the annual exclusion. So how exactly does a “Crummey Demand Right” work? Let’s assume that the spouse of the insured and two children are the beneficiaries of the ILIT and that the annual insurance premiums are $25,000. In the Crummey case, the ILIT gave the beneficiaries the right to demand from the principal of the trust an amount equal to the respective beneficiary’s share of the annual contribution. For technical reasons, the spouse should never have a demand right (that is, the right to ask for a portion of the contribution) in excess of $5,000. Therefore, under our assumed facts, the spouse has a right to demand from the trustee $5,000 and each child has the right to demand up to $10,000 (their share in the contributed amount). Because the beneficiaries have the right to demand that the trustee give them their share of the contributions, the tax court has held that the contributions represent a present interest gift, because all the beneficiaries have to do is ask for the money. If the insured contributed an existing policy, the demand right enables the beneficiaries to demand an interest in the policy. It is necessary to coordinate the demands with the current year’s annual exclusion amount. What if I already have a life insurance policy that I want to put in the ILIT? If the insured has a preexisting policy, that policy may be contributed to the ILIT. However, there are a few added wrinkles. First, a value must be determined to figure out how much of the annual gift exclusion gets used in the year the existing policy is contributed. Also, if you transfer an existing policy, you must survive three years from the date of the transfer to be able to exclude the insurance proceeds from your estate. If you don’t, then the full value of the death proceeds are included in your taxable estate. What happens if the beneficiary demands their share of the money I contribute for the premium? If the beneficiaries demand the money, the Trustee must give it to them. This can put into motion a number of unexpected and undesirable events. The insurance policy may lapse if there is not adequate money with which to pay the premiums. With the life insurance policy lapsed, the beneficiaries receive no future benefit. Depending on your health at the time, you may not be adequately insurable and your demanding beneficiaries have just unraveled an important and valuable element of your estate plan. It is essential that the beneficiaries understand that although their right to exercise their withdrawal demand is real, it is to their economic advantage to simply ignore the ability to demand and let the right to withdraw lapse. What does it mean for a beneficiary’s withdrawal right to lapse? The right of a beneficiary to demand their share of a contribution is only in existence for a limited period of time. Typically, the demand right begins on the date of a contribution and terminates 30 days after the trustee notifies the beneficiaries of their ability to demand their share of the contribution. However, for technical generation skipping tax reasons, the spouse’s right expires no later than 59 days after the date of the contribution. If the beneficiaries do not demand their share of the contribution, their right to do so lapses on the 31st day after the beneficiaries were notified by the Trustee that a contribution had been made and they could demand their share. The IRS approves demand rights that lapse, so the beneficiaries should not waive their rights, because waivers might not be considered a lapse by the IRS. What does the notice to the beneficiaries contain? Generally, the notice needs to include the amount of the contribution and a statement that the beneficiary has a right to the lesser of the beneficiary’s pro rata share of the contribution or the amount of the annual gift tax exclusion available to the insured for that year for that beneficiary. As an example, let’s assume the Grantor makes a contribution of $40,000. The spouse is limited to $5,000 so the remaining $35,000 equals $17,500 for each child. However, because the demand right is limited to the lesser of the beneficiaries’ respective ratable share of the contributed amount or the annual gift exclusion ($11,000), each child would only be able to withdraw $11,000. The amount of the contribution in excess of the annual gift exclusion must be charged against the Grantor’s lifetime gift exclusion (presently $1,000,000). Finally, the notice also needs to contain a description of when the demand right lapses. We have provided a sample Demand Right Notification for your reference. Does the ILIT have to file an income tax return? Not usually. A trust does not have to file an income tax return unless it has gross income in excess of $600 or any taxable income. If the premium contributions are not placed in an interest bearing account, most ILITs will not have any income. If this is the case, then no income tax return is needed. If there is some interest income, the ILIT can pay for the trustee’s administration so as to offset any taxable income. The ILIT will need to obtain a taxpayer identification number in case a return is needed. The IRS may send the trustee a request for a tax return, but all that is needed is to write the IRS and tell them there was no gross income. Documenting the Administration of the Trust
This is the form the Trustee will file with the IRS to obtain a taxpayer identification number for the ILIT, if necessary or desirable. If your Trustee is fairly computer savvy, he or she may obtain the EIN online from the IRS’s website, www.irs.gov (b) Grantor’s Notification to the Trustee of a Contribution The Grantor should notify the Trustee in writing when a contribution has been made to the trust. This will notify the Trustee that it’s time to send out a Demand Right Notification. (c) Demand Right Notification This is the notice that the Trustee provides for the beneficiaries informing them that a contribution has been made to the trust, how much each beneficiary is entitled to withdraw, and the time period allotted for the expiration of the demand right. (d) Receipt and Acknowledgement of Demand Right Although not required, it is a good idea to have the beneficiary sign a receipt acknowledging that they have received their Demand Right Notification. Final Remarks An ILIT can be a very powerful and effective element to a well-designed estate plan, and can provide a great deal of benefit to you in your estate planning and to the beneficiaries your leave behind. As with any sophisticated technique, there are certain administrative requirements and important documents to be maintained. Please contact our office if you have any further questions regarding an ILIT. |
GONNELLA & MAJORS, PC
Attorneys and Counselors at Law
 | |  | |  | |  | |  | |  | |  |
| Gonnella & Majors, PC ▪ 575 South Willow Street ▪ P.O. Box 1226 ▪ Jackson, WY ▪ 83001 Phone (307) 733-5890 ▪ Facsimile (307) 734-0544 ▪ www.wyomingestatelaw.com Disclaimer: Wyoming Rule of Professional Conduct 7.3(b), requires a notification that this is an advertisement. The Wyoming State Bar does not certify any lawyer as a specialist or expert. Anyone considering a lawyer should independently investigate the lawyer’s credentials and ability, and not rely upon advertisement or self– proclaimed expertise. |
Gonnella & Majors, PC
P.O. Box 1226
575 South Willow Street
Jackson, WY 83001
(307) 733-5890
(307) 734-0544 Facsimile
www.wyomingestatelaw.com
Irrevocable Life Insurance Trust - ILIT