Survivorship Life (SL) is treated in the same manner as other types of insurance for estate tax purposes, with certain special consideration, and policy pays death proceeds only upon the second death of two insureds. Estate tax consequences may or may not arise as of the first death depending on who owns the policy. (Throughout the following discussion, please keep in mind that insurance proceeds received by an insured’s estate generally are also included in the insured’s estate under Code section 2042 even if the insured is not the policyowner.) Basically, the policy may be owned in one of three ways:
A third party may own the policy.
- One or the other insured may own the policy exclusively.
- Both insureds may jointly own the policy.
- Similar to any other insurance policy, if neither insured has any incidents of ownership in the policy and they have not transferred ownership within three years of death, it will not be included in the gross estate of either insured. However, under the three-year rule of Code section 2035, the policy will be included in the estate of the second to die if, and only if, both spouses die within the three-year period after the policy is transferred and the transferor spouse is the last to die.
If both spouses die within the three-year period and the transferor spouse is the first to die, there should be no inclusion of the proceeds under section 2035.3 If the transferor is the first to die, the policy would not have been included in his or her gross estate under Code section 2042 or any of the other specified code sections had the transfer not been made. Therefore, the policy proceeds do not fall within the scope of section 2035 and should not be included in the gross estate of either insured if the transferor is the first to die within the three-year period following a transfer of the policy.
Under Code section 2033, an insurance policy owned by the decedent on the life of another is included in his or her gross estate at the replacement cost of comparable policies of the issuing company or the interpolated terminal reserve.4 If both insureds own the policy jointly, the deceased’s portion of the policy’s value (which is arguably best determined as the actuarial value of his or her probable survivorship benefits estimated as if he or she had not died) is included in his or her gross estate.
If the deceased transfers the policy by will to the surviving insured who is the decedent’s spouse, the transfer qualifies for the marital deduction. In this case, there will be no estate tax at the first death. If the surviving insured becomes the owner of the policy when the first insured dies and continues to own the policy until the second insured’s death, the proceeds of the policy will be included in the second insured’s gross estate. However, if the policyowner who dies first transfers the policy by will to someone other than the surviving insured, the proceeds generally will not be included in the gross estate of the surviving insured when the surviving insured dies. The proceeds would be included only if the three-year rule of section 2035 discussed above applied or if the surviving insured retained an incident of ownership in the policy.
If the second insured dies within six months after the policyowner dies and the policyowner’s executor elects to have the assets of the estate valued as of the alternate valuation date, then the proceeds of the policy will be included in the policyowner’s estate. The death benefits will not be included in the estate of the second to die (assuming he or she was not the policyowner at any time within three years of his or her death and proceeds are not received by his or her estate).
If the insured who does not have any incidents of ownership in the policy dies first, nothing will be included in his or her estate because the policy proceeds are not payable at his or her death and such insured has no ownership rights in the policy. At the owner-insured’s later death, the proceeds will be includable in the owner-insured’s gross estate, unless he or she has transferred the policy more than three years before his or her death and has retained no incidents of ownership.
Estate Inclusion When Policy Owned by Corporation
If a key employee/controlling stockholder of a corporation dies and the corporation has complete control over the policy or at least the right to borrow against the policy, the employee/stockholder will be treated as having sufficient incidents of ownership for the policy to be included in his estate.5
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM