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Divorce.

640. If life insurance proceeds are required under terms of a property settlement agreement or a divorce decree to be paid to certain beneficiaries, are the proceeds includable in insured's estate? Is an offsetting deduction allowable?

Includability of Proceeds or Premiums

The Internal Revenue Service has ruled that where a divorced wife had an absolute right, under terms of a property settlement agreement incorporated by reference in a divorce decree, to annuity payments after the death of her former husband, such payments to be provided by insurance on his life maintained by him for that purpose, the former husband possessed no incidents of ownership in the insurance at his death; no part of the insurance proceeds was includable in his estate. (3) (See Q 626 for the general rules of includability.) Also the Tax Court has held that where a divorced husband was required under a property settlement agreement to maintain insurance on his life payable to his former wife, if living, otherwise to their surviving descendants, otherwise to his former wife's estate-the insurance, in other words, was not merely security for other obligations-the insured possessed no incidents of ownership in the insurance. (4) The Tax Court has also held that where an insured was subject to a court order requiring him to maintain insurance on his life payable to his minor children, such court order, operating in conjunction with other applicable state law, effectively nullified incidents of ownership the insured would otherwise possess by policy terms. (1)

Where, on the other hand, the divorced husband was merely required to maintain a stated sum of insurance on his life payable to his former wife so long as she lived and remained unmarried, the insured was held to have retained a reversionary interest sufficient in value to make the proceeds includable in his estate (see Q 631). (2) It has also been held that where, pursuant to a divorce decree, the proceeds of insurance maintained by a divorced husband on his own life to secure alimony payments, are paid following the insured's death directly to the former wife, the proceeds are includable in the insured's estate. It was reasoned that since the proceeds satisfy a debt of the decedent or his estate, the result is the same as if the proceeds are received by the decedent's executor (see Q 626). (3)

Availability of Estate Tax Deduction

Where insurance proceeds payable to a divorced spouse are required to be included in the insured's estate, it is sometimes possible to secure an offsetting deduction either (1) on the basis that the beneficiary's right to the proceeds amounts to a claim against the estate representing a personal obligation of the decedent existing at the time of his death, (4) or (2) on the basis that the beneficiary's interest in the proceeds amounts to an indebtedness against the proceeds included in the estate. (5) However, a deduction is not allowed on either basis if the claim or indebtedness is founded on an agreement between the spouses in the nature of a property settlement agreement not supported by "adequate and full consideration in money or money's worth." (6) But where property is transferred from a decedent or from a decedent's estate to a former spouse of the decedent pursuant to a property settlement agreement, and divorce occurred within a three-year period measured from the date one year before the agreement was entered into, and where the property is includable in the decedent's gross estate, the transfer is considered to be made for an adequate and full consideration in money or money's worth. (7) A relinquishment or promised relinquishment of marital rights in property is not consideration in money or money's worth. (8) Although it has been held that a wife's right to support is a "marital right in property" within the meaning of the statute, (9) IRS has declined to follow the decision (10) and declares instead that a release of support rights by a wife constitutes a consideration in money or money's worth. (11) The Tax Court has consistently agreed that a wife's relinquishment or promised relinquishment in a separation agreement of her support rights is a consideration in money or money's worth. (12)

But even though it is found that the relinquishment or promised relinquishment of support rights is consideration in money or money's worth, it must also be found that the claim or indebtedness against property was "contracted bona fide and for an adequate and full consideration in money or money's worth." (13) It must be found, in other words, that that which is sought to be deducted from the estate was bargained for in exchange for support rights. Thus, the executor of the estate must be prepared to show, according to applicable local law, just what was the value of the wife's support rights at the time the separation agreement was entered into. If he is unable to establish a dollar value by any reasonable approach, such as taking into account the value of the marital assets and the former spouses' incomes and their expenses, the deduction sought will be denied. (1) If a dollar value of the support rights is established, the deduction allowed cannot exceed that amount or, if less, the amount of the claim.

If, then, insurance proceeds are payable to a former spouse pursuant to the terms of a property settlement agreement (but not pursuant to a court decree), the insured's estate may be permitted an offsetting deduction to the extent of the value of any support rights relinquished by the wife under the agreement. (2) But to the extent the proceeds exceed the value of such support rights, no deduction is allowable if the only other consideration given by the wife was relinquishment or promised relinquishment of inheritance rights in the decedent's property. For information on how to value support rights, see Revenue Ruling 71-67 (3) and Est. of Fenton v. Comm. (4)

Where a property settlement agreement is incorporated in a divorce decree, and where the divorce court is free to ignore the allowances made in the agreement and to set different allowances in its own discretion instead, the obligations of the parties are not "founded upon a promise or agreement" but upon the divorce decree. In this case, a deduction of a proper claim or indebtedness under IRC Section 2053 is allowable without regard to the nature of the consideration given by the wife. (5) Even if both the agreement and the court decree provide that the covenants in the agreement shall survive any decree of divorce that may be entered, the obligations of the parties are still founded on the court decree, not on a promise or agreement. (6)

On the other hand, where a property settlement agreement is incorporated in a divorce decree, but under applicable state law the divorce court is not free to disregard the provisions of a valid property settlement agreement, the obligations of the parties are held to be founded upon a promise or agreement and not upon the divorce decree. In such case, the availability of the offsetting estate tax deduction is limited as previously explained. (7) Also, IRS has ruled that where life insurance proceeds were payable to insured's minor children pursuant to a divorce decree, the deduction was not allowable because (1) the decree exceeded the support obligation imposed by state law in requiring the spouse to maintain insurance on his life payable to his children, and (2) the maintenance of the insurance was not contracted for a full and adequate consideration. (8)

Deduction as Claim Against the Estate

IRS has held that availability of the deduction under IRC Section 2053(a)(3) depends upon the nature of the insured's legal obligation under the divorce decree. If the insured's obligation was simply to keep the policy in full force and effect with all premiums paid as long as the former spouse lived and remained unmarried, and he did that, then no obligation survived his death and his estate would not be entitled to a deduction. If, on the other hand, the divorce decree provided for the payment, upon the decedent's death, to his former spouse of a specific sum of money and he provided funds there-for by the purchase of life insurance, then the payment of the required amount would be a personal obligation of the decedent, and should the insurer be unable to meet its obligation, would be payable from his estate; under these circumstances, any proceeds payable to the former spouse to discharge the decedent's obligation would be deductible under IRC Section 2053(a)(3). (1)

Deduction as Indebtedness Against Proceeds

The Tax Court has allowed an offsetting deduction under IRC Section 2053(a)(4) where a divorced husband was required under the terms of a property settlement agreement incorporated in a divorce decree to maintain a certain amount of insurance on his life payable to his former wife, and where the proceeds were paid upon his death directly from the insurer to the former wife as beneficiary. The court held that the proceeds were property included in the estate and subject to an indebtedness even though, because the proceeds were paid directly to the former wife, it was not necessary for her to file a claim against the estate. (2) The Tax Court has also allowed a deduction under IRC Section 2053(a)(4) where the decedent had been ordered through a divorce decree to assign two policies to his former wife. (3)

The position of the Internal Revenue Service now is that where a divorced spouse is required by the terms of a divorce decree to maintain insurance on his life payable to his former spouse, until the beneficiary spouse dies or remarries, an offsetting deduction is allowed the estate under IRC Section 2053(a)(4). (4) (On these facts, the deduction would not be allowed under IRC Section 2053(a)(3)-see above.)The IRS has ruled similarly where in a paternity action adjudicating custody and support rights the insured was required by court decree to maintain insurance on his life for the benefit of his child. (5)

(3.) Rev. Rul. 54-29, 1954-1 CB 186.

(4.) Est. of Bowers v. Comm., 23 TC 911 (1955), acq. 1955-2 CB 4.

(1.) Est. of Beauregard v. Comm., 74 TC 603 (1980), acq. 1981-1 CB 1.

(2.) Rev. Rul. 76-113, 1976-1 CB 276.

(3.) Est. of Mason v. Comm., 43 BTA 813 (1941).

(4.) IRC Sec. 2053(a)(3).

(5.) IRC Sec. 2053(a)(4).

(6.) IRC Sec. 2053(c)(1)(A).

(7.) IRC Sec. 2043(b)(2).

(8.) IRC Secs. 2053(e), 2043(b).

(9.) Meyer's Est. v. Helvering, 110 F.2d 367 (2nd Cir. 1940), cert. den. 310 U.S. 651.

(10.) Rev. Rul. 68-379, 1968-2 CB 414.

(11.) Rev. Rul. 71-67, 1971-1 CB 271; Rev. Rul. 75-395, 1975-2 CB 370.

(12.) McKeon v. Comm., 25 TC 697 (1956); Est. of Glen v. Comm., 45 TC 323 (1966); Est. of Iverson v. Comm., 65 TC 391 (1975), rev'd and remanded on another issue, 552 F.2d 977 (3rd Cir. 1977); Est. of Satz v. Comm., 78 TC 1172 (1982). See also Bowes v. U.S., 77-2 USTC [paragraph] 113,212 (N.D. Ill. 1977).

(13.) IRC Sec. 2053(c)(1)(A).

(1.) Est. of Iverson, Est. of Satz, both cited above.

(2.) Gray v. U.S., 78-1 USTC 113,244 (C.D. Cal. 1978), on remand; Est. of Fenton v. Comm., 70 TC 263 (1978).

(3.) 1971-1 CB 271.

(4.) 70 TC 263 (1978).

(5.) Comm. v. Maresi, 156 F.2d 929 (2nd Cir. 1946); Comm. v. Est. of Watson, 216 F.2d 941 (2nd Cir. 1954), acq. 1958-1 CB 6; Young v. Comm. 39 BTA 230 (1939); Est. of Mason v. Comm., 43 BTA 813 (1941).

(6.) Harris v. Comm., 340 U.S. 106 (1950); Est. of Robinson v. Comm., 63 TC 717 (1975).

(7.) Est. of Bowers v. Comm., 23 TC 911 (1955), acq. 1955-2 CB 4; Est. of Barrett v. Comm., 56 TC 1312 (1971); Gray v. U.S., 541 F.2d 228 (9th Cir. 1976), reversing and remanding 391 F. Supp. 693; Est. of Satz v. Comm., 78 TC 1172 (1982); Rev. Rul. 60-160, 1960-1 CB 374; Rev. Rul. 75-395, 1975-2 CB 370.

(8.) Rev. Rul. 78-379, 1978-2 CB 238.

(1.) Rev. Rul. 76-113, 1976-1 CB 276.

(2.) Est. of Robinson v. Comm., 63 TC 717 (1975), acq. 1976-2 CB 2.

(3.) Est. of DeVos v. Comm., TC Memo 1975-216.

(4.) Rev. Rul. 76-113, 1976-1 CB 276.

(5.) Let. Rul. 8128005.
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Title Annotation:PART II: FEDERAL ESTATE TAX ON INSURANCE AND EMPLOYEE BENEFITS
Publication:Tax Facts on Insurance and Employee Benefits
Date:Jan 1, 2010
Words:2093
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