Estate Required to Include Value of Insurance Policies Which Decedent had an Incident of Ownership
From WS+B Estate and Trust Expert Hal Terr
In Estate of Edward Thomas Coaxum v. Commissioner, T.C. Memo. 2011-135, the Tax Court held that the executor should have included the value of six life insurance policies on which the decedent was the insured and retained the right to change the beneficiaries of the life insurance policies during his lifetime. In addition, the Tax Court determined the estate should have included the value of an annuity owned by the decedent and did not agree with the estate’s argument that since the distribution from the annuity was subject to income tax by the beneficiary that the annuity should not be included in the gross estate.
Under IRC Section 2042, the value of the gross estate shall include the value of all property of a decedent (1) to the extent of the amount receivable by the executor as insurance under policies on the life of the decedent and (2) to the extent of the amount receivable by all other beneficiaires as insurance under policies on the life of the decedent with respect to which the decedent possessed at death any of the incidents of ownership. Under IRC Reg. 20.2042-1(c)(2), an incident of ownership is the power to change the beneficiary of the insurance policy.
The decedent died on October 15, 2003. Although the estate tax return is required to be filed within 9 months after the date of death (unless granted an extension by the IRS), the executor did not file the estate tax return until February 27,2006. The decedent was the insured of six policies with a total death benefit of $1,283,184 which he possessed the power to change the beneficiaries on all six policies until he died. Due to the preponderance of evidence that the decedent retained the right to change the beneficiaries until his death, the estate could not overcome the burden of proof under Rule 142(a)(a) that the notice of deficiency was incorrect.
Under IRC Section 2039(a) provides that the value of annuities owned by the decedent is included in the value of the gross estate. The estate argued that since the named beneficiary had to pay income tax on the distribution received from the annuity, the value of the annuity should be excluded from the gross estate. Although the Tax Court did not rule since it was beyond its jurisdiction, it was found that the annuity should be included in the gross estate and the named beneficiary would receive a IRC Section 691(c) deduction for the estate tax attirbutable for the annuity’s inclusion in the gross estate to offset the income inclusion on the benficiary’s individual income tax return.
Finally, the estate was assessed a failure to file penalty of 25% of the net estate tax due since the executor filed the estate tax return more than five months late. The estate tax deficiency was $337,193 so the assessed penalty totaled $84,298. The Tax Court found the executor did not meet the reasonable cause exception and the failure to file was due to willful neglect.
What can be learned from this case? With the increased estate exemption, more and more taxable estate tax returns will be reviewed by the IRS. In addition, since life insurance death benefits are reported by the insurance companies to the IRS on Form 712, the IRS is receiving the information from independent third parties of amounts that should be included in the gross estate of a decedent. Since the burden of proof is on the taxpayer to prove otherwise, executors need to make sure they obtain competent advice on the items that should be included in the gross estate to avoid additional tax and penalties.
