IN Estate of Becker v. CommissionerThe Tax Court held that the step transaction doctrine did not apply to the ownership of an irrevocable trust of life insurance policies on the grantor's life and the insurance policy proceeds were not included in the taxpayer's estate under Maryland state law and Internal Revenue Code Sections 2031 and 2033.
The trust acquired two life insurance policies
Dr. Larry Becker created an irrevocable trust in 2014. Later that year, the trust acquired two life insurance policies on his life. Larry never had an interest in either policy, as the trust was the original owner and beneficiary of both policies. One policy had a death benefit of $11.47 million and required an initial premium of $999,963, and the other policy had a death benefit of $8 million and required an initial premium of $697,257.
To pay the initial premiums, the trust borrowed funds from Larry. Larry, in turn, borrowed the funds from Barry Steinfelder, the insurance broker who had helped procure the policies. Barry, on the other hand, borrowed from an acquaintance to obtain such funds. No receipt or other memoranda showed Larry's credit to the trust for the payment of the initial premiums for the insurance policies. Barry paid off the loans. To memorialize the remaining debt, promissory notes were issued showing a loan owed by the trust to Barry, in lieu of two sets of loans, one from the trust to Larry and another from Larry to Barry (the issued to ALD, LLC, an entity controlled by Barry, rather than Barry individually). Under this agreement, Larry was not entitled to receive any funds from the trust.
The trust entered into an agreement with LT Funding, LLC, which provided that LT Funding was obligated to pay future premiums on policies owned by the trust, and in return, would be entitled to: (1) 75% of the death total policy benefits, (2) all premiums advanced by LT Funding and (3) interest on all premiums advanced by LT Funding at the rate of 6% per annum. Pursuant to a “Subordination and Intercreditor Agreement,” LT Funding's security interest in the policies took priority over ALD, LLC's interest.
Larry died in 2016 and the death benefits from both policies (totaling approximately $19.5 million) were paid to the trust. LT Funding, ALD, LLC and others disputed what each party owed of that amount. The parties eventually settled, with LT Funding being paid $9 million.
Maryland Law and the Hap Transaction Argument
Under Maryland law, if a person enters into a contract to insure the life of another without an “insurable interest” in such person's life, the contract is deemed to constitute gambling which is against public policy, which voids the interest. of the contracting party (Md. Code Ann., Ins. Sec. 12-201(a) (West 2024)). As an entity unrelated to Larry, LT Funding would not have an “insurable interest” in Larry's life and, therefore, would not be entitled to procure a policy on Larry's life for the benefit his. Further, under Maryland law, if LT Funding were held to have impermissibly provided insurance on Larry's life, then Larry's estate would have a cause of action to recover the proceeds of a such policy (See Md. Code Ann., Ins. Section 12- 201(d)),
The Internal Revenue Service argued that when the described transactions fell under the step transaction doctrine, the death benefits of the policies were not initially primarily for the benefit of the trust beneficiaries, but were impermissibly procured by LT Funding. Accordingly, if Larry's estate would accordingly have a cause of action to recover the proceeds of such policy pursuant to state law, but such proceeds would be included in Larry's estate pursuant to IRC Sections 2031 and 2033.
Court holding
The court held that under the “ultimate result” test and the “interdependence” test, the transactions in question should not be collapsed and the step transaction doctrine does not apply. The final result test is not satisfied because the subjective intent of the parties at the outset was not for LT Funding to provide a death benefit on Larry's life for its own benefit (ie, there was no prior agreement or understanding at the outset as to this outcome ). The court further held that the interdependence test was not met because the purchase of the policies was not dependent on the agreement with LT Funding, because the policies were fully funded for 30 months by the payment of initial premiums, and Larry and the trust. there were several financing options for premiums due beyond that period (including Larry's own substantial assets of over $25 million); they used LT Funding because it was the option they determined was the most financially beneficial for Larry and the trust beneficiaries.