Dumont & Watson, P.C. 2025-03-31T11:54:39Z https://www.dumontwatson.com/feed/atom/ WordPress /wp-content/uploads/sites/1103137/2023/04/cropped-Dumont_dir-32x32.jpg On Behalf of Dumont & Watson, P.C. https://www.dumontwatson.com/?p=47277 2023-05-11T18:42:59Z 2023-05-11T18:42:59Z

Uses of Irrevocable Life Insurance Trusts Ordinary life insurance is often used by those with smaller estates to provide a legacy, or to infuse capital into the estate to pay for necessary expenses. It can also be used as a vehicle to fund a business buy-sell agreement, which provides for the purchase of a decedent's interest in the business. The common misconception is that insurance of this type is a totally tax-free vehicle. Life insurance is includable in the gross estate of the insured if the decedent had any "incidents of ownership" in the contract, no matter who the beneficiary is. Even if the decedent did not own the policy, but he or she had received benefits from the policy or had the power to change, assign, revoke, pledge it for a loan or borrow from it, the decedent would be considered to have incidents of ownership. Also, if the policy is paid to the insured's estate, he or she would be deemed to have sufficient interest in it to include the proceeds in the estate valuation. Therefore, although not taxed when received, life insurance proceeds can create a taxable estate when the money is left to heirs. The Problems of Alternative Ownership Although the spouse may not own a policy, the children may own a policy to avoid "incidents of ownership" in the insured. However, there are disadvantages. For example, I) children may misuse the policy and cash it in for themselves, 2) the spouse of a child may claim the cash value in a divorce proceeding, as part of his or her "equitable distribution", 3) if the child predeceases the parent, the issue of ownership becomes problematic, 4) the beneficiaries will immediately control the proceeds without guidance or restriction, and 5) the beneficiaries may have disabilities for which they receive government benefits. If that is the case, payments of the proceeds will disqualify them for a significant period of time, until they spend down the money. The Practical Aspects of an Irrevocable Insurance Trust (ILIT) The Trustee is considered the applicant for the insurance policy, the owner and beneficiary of the policy. If the policy is an existing one, the insured assigns the ownership to the Trustee by means of an assignment. Each year, the insured gives a gift to the Trustee of the funds sufficient to pay the annual premium. Usually, the surviving spouse is the primary beneficiary of the Trust, providing income to her for the rest of her life. Upon the death of the surviving spouse, the moneys flow to the children with the proceeds maintained for them in trust until they are of age. (In some cases, Irrevocable Life Insurance Trusts may utilize a "second-to-die" policy which distributes the proceeds to the children only upon the surviving spouse's death.) Although not specifically stated in the Trust document, the Trustee is also permitted to utilize the proceeds to pay the anticipated estate taxes prior to the distribution to the children. In the event that the Grantor funds the Trust with cash in addition to an insurance policy, income or principal may be distributed for the beneficiaries' health, education or welfare, or support or maintenance. If the Grantor utilizes an existing policy by transferring said policy into the Trust rather than creating a new policy, the value of the initial gift is the "interpolated terminal reserve value" according to Regs. Section 25.2512-6 (a). This value can be obtained by requesting the interpolation from the insurance company. If the decedent had transferred all rights or interest in the policy to the Trust within three (3) years of death, the proceeds come back into the estate since it was deemed to be a gift within three (3) years of death. IRC § 2035(d)(2). If the Grantor purchases a new policy to fund the ILIT, the insurance is deemed part of the insured's estate if he or she dies within three (3) years of the issuance of the policy. At its heart, the ILIT uses the annual tax-free gifting to beneficiaries as the device which serves to exclude the insurance proceeds from the Estate. According to Crummey v. Commissioner, 68-2 USTC Par. 12,541 (9th Cir. 1954), the Court held that the payment of the premium would qualify for the annual gift exclusion if the beneficiary "had the present right, whether exercised or not, to withdraw from the trust corpus amonnts from the annual contributions." Therefore, the Trustee must send the beneficiaries annual notices in a timely manner indicating that the beneficiary has the right to withdraw the cash value of the gift within a certain amount of time. That is, they have the right to demand up to their pro rata share of the annual premium up to the amount of the then current annual gift exclusion (presently $12,000). The beneficiary must have actual notice and must have approximately thirty (30) days to respond. The notice may be given to a guardian if the beneficiary is a minor. Each beneficiary must be given separate notice. The case of Cristofani v. Commissioner, 97 TC No. 5 (1661) acq. 1992- 1, C.B. 1, held that contingent beneficiaries also need to be notified. If the time lapses and the child does not exercise his or her right of withdrawal, the lapse itself is considered an exercise of the gift according to IRC §2514 (b). 1 1 "Tax Aspects of Elder Law", NJ !CLE Jenkins, Cynthia. Irrevocable Life Insurance Trusts.]]> On Behalf of Dumont & Watson, P.C. https://www.dumontwatson.com/?p=47271 2023-05-11T18:18:45Z 2023-05-11T18:18:05Z

Unrelated Business Income One of the concerns of religious and secular charities is whether the profit obtained from a commercial venture constitutes too great a percentage of its revenues. The income from a commercial venture is designated as “Unrelated Business Income” or “UBI”. If the income from this venture exceeds even five (5%) percent of the total revenues, the tax exempt status of the charity may be put into jeopardy. However, the IRS recently broadened the scope of permissible UBI in certain cases. In one case in particular, which is memorialized in Technical Advice Memorandum #200021056, dated February 8, 2000, the IRS ruled that in this instance the tax exempt status would not be revoked even though the organization earned 62% of its gross income from taxable UBI. In times past, churches opened small book stores or gift shops within its walls to hawk tapes and a few books of particular relevance with the genuine concern that although income tax is paid on the revenue, the status of the non-profit may be placed in jeopardy if the private, for-profit enterprise is “too successful.” This ruling opens the door for religious and other non-profit organizations to broaden the scope of their ministries to incorporate commercial enterprise, increase their income, better serve their constituencies, reduce the burden of dependence upon charitable giving, raise their status and visibility in the communities they serve and bolster their bottom line. It also serves to endorse and encourage creative solutions to the age-old question of producing sustainable economic viability by small organizations. The ABC Charity (the IRS withheld the actual name for its own protection) had been recognized as a 501(c)(3) organization. Its purpose, as stated in the Articles of Incorporation was “to establish and maintain. ..a place for the reception, exhibition and sale of articles, the product and manufacture of industrious and meritorious women” and “generally to assist the needy and deserving women in their efforts to earn an honest livelihood by their own industry”. (Technical Adv. Memo. #200021056 at Page 259.) ABC claimed that its sole purpose was to aid such women to earn their own living by providing a place for them to sell their own handiwork and foods. ABC operates three contiguous shop on site -- a consignment shop, tea room and gift shop. The consignment store is operated by volunteers as well as paid employees and displays the handiwork of the women they serve. The gift shop is also managed by volunteers and paid employees purchasing decorative items from for-profit vendors for retail sales to the general public. The tea room, also managed by both volunteers and paid employees, is a luncheon facility which is open to the general public and consists of a dining room and kitchen. The consignment shop is the portion of the enterprise which works most closely with the needy women in the community. ABC selects women as consignors who produce handcrafted toys and clothes for purchase by the general public. Each crafted benefits financially from the sale of the item on a consignment basis. According to ABC, the consignors have heard about the program by word of mouth and ABC publicity campaigns. Volunteers from ABC's membership evaluate the work of the proposed consignor for suitability. Once accepted, the members educate her on how to make goods that people will buy and for which they will pay high prices. They train the ladies thoroughly on fashion, fit, style, fabric, color, sewing and type of products. All work is supervised by ABC which sells its fabrics and other raw materials to the consignors at cost. The goods are sold in the shop to the general public. ABC found that the consignment shop in and of itself would not bring in the prospective customers in sufficient numbers. It would be perceived as a “craft fair” with a few hand-made goods of secondary quality. As a result, the volunteers of ABC purchase decorative items from regular for-profit wholesale vendors for placement in the gift shop which is adjacent to the consignment shop. ABC stated that in order to attract quality clientele, it must 1) provide a reason for people to come to the shop which exposes them to the consignment items, 2) possess a showroom with the quality and ambiance that repeatedly attracts high end customers, and 3) provide attractive merchandising that suggests quality. ABC asserted that the gift shop goods were “sophisticated, tastefiil and fashionable” and because they appear in the same shop as the consignment goods, they enhance the consignment items. In order to enhance the prices of the consignment items, ABC developed a pricing strategy: 1) gift shop items cover a broader price range than consignment items with a greater number of goods in the low and high end. The low end items give the customers a sense of “bargain and comfort,” while the high end items steer the clientele to the mid- range prices where the consignment items are situated. The price for the consignment items covers a range between $4.50 and $250.00, while the gift shop prices range from $1.50 to $1,500. After setting aside the highest end items, ABC stated that the representative sales from consignment items range from $4.40 to $95.00, while the range for the gift shop covers from $1.50 to $150. The tea room is adjacent to the consignment and gift shops and serves lunches to the general public. All of the food consumed is purchased from regular for-profit vendors. ABC intentionally placed the tea room in such a way that in order to use it, customers would have to meander through the gift shop. It serves only light lunches which is deemed ideal for shoppers and the menu, decor, room arrangement and tableware is designed to be tasteful and sophisticated. ABC intended the tea room to enhance the shopping experience and to create a social activity. Three paid employees and three volunteers staff the facility. It is important to note that ABC contends that its only purpose for the gift shop and the tea room is to further its clearly stated primary purpose of assisting people who have faced adversity to help themselves out of their difficult situation, and that the gift shop and tea room merely exists to support the handicrafts by attracting customers and help by generating funds to support its exempt purposes.]]>