There are questions surrounding life insurance valuation. Life insurance is a big deal in any household. Without it, you’d have to worry about your loved ones. There are many options to choose from when it comes to buying life insurance. Our experts answer some questions revolving around this topic.
Question – If a client who owns a policy is considering gifting the policy and also exchanging the policy for a better performing policy, is it better for gift valuation purposes to gift the policy first or do the 1035 exchange first?
Answer – There is no clear answer to this question and the client should seek guidance from his or her tax and legal advisor. The key issue is whether the policy received in the 1035 exchange constitutes a new policy for purposes of applying the IRS guidance, or is considered a continuation of the old policy.
If the client’s tax and legal advisor decides it should be treated as a new policy, then the FMV of the newly exchanged policy, assuming it is transferred within a year of the exchange, should be the cost of the newly exchanged policy (i.e., gross premiums paid, which is the cash surrender value transferred from the old policy plus any additional premium paid into the new policy). In this situation it would likely be more advantageous from a gift tax valuation standpoint to complete the 1035 exchange first and then gift the newly exchanged policy. This is because the value of the newly exchanged policy (gross premium paid into the new policy) may be lower than the value of the old policy (ITR).
However, if the client’s tax and legal advisor determines that the newly exchanged policy is a continuation of the old policy for valuation purposes and that ITR applies, then the answer generally depends upon the type of product into which the client is exchanging. In general, a lower ITR value may be achieved by doing the 1035 exchange first and then gifting the newly exchanged policy. However, the ITR values for products with no-lapse guarantees are generally going to be higher than the ITR values for nonguaranteed products; and in some cases will be substantially higher. Therefore, if the 1035 exchange is from a nonguaranteed product into a no-lapse guaranteed product, it may be beneficial for the client to make the gift first and base the gift on the ITR value of the old product.
Question – Is unearned premium the appropriate value to use with all term products?
Answer – Although the value of an ART product is unearned premium, level term products generally have an ITR value and thus, the value of level term products will generally be higher than the unearned premium.
Question – How is a life insurance policy that is being gifted to a charity valued?
Answer – The amount of the deduction for a charitable gift of a life insurance policy is generally the lower of: (a) the FMV of the policy; or (b) the donor’s cost basis. Therefore, where the FMV at the date of the gift is greater than the net premiums the client has paid, the deduction will be limited to the client’s net premiums.
FMV is generally determined for gifts of life insurance in general. However, if the FMV of the policy is greater than $5000, then a qualified appraisal must be obtained pursuant to Code section 170(f)(11)(E). Neither the donor, the insurance agent, nor the insurer who issued the policy can perform this appraisal.
Question – What are the options if the client is unhappy with the gift or estate tax value of a life insurance valuation policy reported by a life insurance carrier on IRS Form 712?
Answer – It is unlikely that you are going to get the insurance company to change their figure, since they have to certify that the information is true and correct and are likely reluctant to change their methodology for one policy holder out of concern of discriminating against all policy holders (this doesn’t mean you shouldn’t try to do so). Since Forms 706 and 709 indicate that the Form 712 should be attached, the best course of action would be to attach the insurance company value and attach an explanation which states why it is not reflective of the FMV. If you don’t attach the Form 712, you may be red flagging the client for an IRS inquiry. Regardless of what you decide to do with the Form 712, if you do decide to use another value, the instructions to Form 712 indicate that you must provide a full explanation as to how the value was determined.
Question – What are some best practice considerations for obtaining a fair and reasonable value of a life insurance valuation policy for a client?
Answer – The following best practice tips may be helpful:
- When you request the value of a policy from an insurance company, be specific about what value you’re looking for (e.g., is it the value for gift, income or some other purpose). Also, if you are requesting the PERC value, be specific about which PERC value you need (i.e., with or without the average surrender factor).
- Start out by informally requesting the value from the insurance company. For example, instead of asking the carrier to send you a Form 712, have some idea what the ITR value on the 712 will be before they send it to you. This might make it easier for you to argue for and obtain an alternative value before the insurance company has formally issued the Form 712.
- Ask the insurance company how they calculated the value that they have informally provided you. Knowing their methodology can put you in a better position to determine if the value you’ve been provided is reasonable.
- Negotiate the value with the insurance company, if possible. Most insurance companies probably won’t be willing to change the number they put on the Form 712, but some companies may be willing to do so due to the ambiguities involved. It certainly doesn’t hurt to ask.
- If all else fails and your client is still unhappy with the value of the policy reported by the insurance company, be prepared to consider another approach, such as obtaining an independent appraisal that can be used to support the explanation provided on the tax return.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM