Any one of seven reasons can cause life insurance to be includable in a decedent’s gross estate. (Note that in some cases inclusion will result in the lifetime value being includable and in other situations the policy proceeds will be included). Planners should always consider the impact of state death taxation, which sometimes parallels federal estate tax law but often diverges significantly.
- Section 2033 Inclusion. The value of life insurance owned by the decedent on the life of another will be includable in the decedent’s estate if the decedent dies first.
- Section 2035 Inclusion. Life insurance proceeds will be includable in the insured’s estate if the insured held an incident of ownership (i.e., any significant ownership right) within three years of death, even if at the date of death the insured didn’t own the policy or any policy rights.
- Sections 2036, 2037, 2038 Inclusion. Policy proceeds will be includable in the insured’s estate if the insured transferred the policy to another party but retained a lifetime right to:
enjoy the legal rights to the policy;
have the policy revert back to him or his estate under certain conditions; or
alter, amend, revoke, or terminate the policy. - Section 2042 Inclusion. If (a) the policy proceeds were paid to (or for the benefit of) the insured’s estate or (b) the insured owned at the date of his death an incident of ownership in the policy, the proceeds will be includable in the insured’s gross estate.
- Section 2039 Inclusion. When a life insurance policy is used as part of the financing of an employee benefit, proceeds may be includable as an annuity.
- Section 2041 Inclusion. If the insured elected a settlement option for a beneficiary and also gave that person a general power of appointment over the policy proceeds, the proceeds will be includable in the beneficiary’s gross estate.
- Section 2044 Inclusion. Life insurance proceeds may be includable in the estate of a beneficiary who was the insured’s spouse and who had received the proceeds as a qualifying income interest for life under QTIP rules.
- We will first briefly focus on the definition of life insurance for federal estate tax purposes and then examine in detail the most common reasons for estate tax inclusion of life insurance, Code sections 2033, 2035, and 2042.
Note that while the 2017 Tax Cuts and Jobs Act increased the amount of the unified estate and gift tax exemption to $11 million ($11,400,000 in 2019 after inflation adjustments), it did not otherwise change the mechanics of the estate tax calculation with respect to life insurance. Also, the TCJA is currently scheduled to sunset on December 31, 2025 taking with it the elevated exemption amount.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM