• Court supports property insurance transactions-IN Estate of Larry Becker v. CommissionerMemo TC. 2024-089 (Sept. 24, 2024), the 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 pursuant to Maryland state law and Internal Revenue Code sections 2031 and 2033.

In July 2014, Larry Becker established an insurance trust for the benefit of his wife and children. Two of his children were appointed as the original trustees. The trust applied to purchase two insurance policies on Larry's life, with total death benefits of nearly $20 million. Policies were issued in the following months. Larry never owned the policies, had no rights, interests or powers over the policies that would be considered incidents of ownership, and did not have or control any beneficial interest in the policies.

The trust borrowed funds from Larry to pay the initial premiums. Larry, in turn, had borrowed the funds from his insurance broker, who borrowed the funds from another individual. The broker issued a promise to a third-party lender for the premiums (over $1 million). Later, a separate limited liability company (LLC), ALD, that the broker owned, paid off the loans issued by the broker to become the direct creditor. Under the restated promissory notes, the trust was obligated to repay ALD and ALD had a security interest in the policies. Not long after, ALD assigned its interest in the notes to another entity, JTR.

At the end of the year, the trust entered into an agreement with LT Funding, a Georgia LLC. LT Funding assumed the obligation to pay future liability premiums for the insurance policies in exchange for 75% of the total death benefits of the insurance policies, plus reimbursement of any premiums advanced by LT Funding, with interest. As part of the agreement, LT Funding was granted security interests in the policies, and under a subordination agreement, LT Funding's interest had priority over JTR/ALD's interests.

Two years later, in 2016, Larry died. Because the initial premiums were paid for 30 months, no premiums were paid between the date of the agreement with LT Funding and Larry's death. The proceeds were paid to the trust, but various creditors disputed their rights to repayment. Under a settlement agreement between the trust, JTR/ALD and LT Funding, the trust paid LT Funding $9 million to release its claims.

Larry's son, as executor, filed his estate tax return, which did not include the value of the insurance policies owned by the trust. The Internal Revenue Service issued a notice of deficiency, asserting that the insurance proceeds were includible in the estate under IRC Sections 2031 and 2042.

Under Maryland estate law, the court determined that the trust had an insurable interest in the insurance policies because the beneficiaries of the trust were Larry's wife and descendants, all of whom have an insurable interest. The insurable interest rule voids the initial purchase of a life insurance policy on the life of another if the purchaser does not have an insurable interest. Close family members have an insurable interest. The public policy behind the rule is to avoid “gambling” the lives of others. If the original purchaser has an insurable interest, policies can be transferred to third parties who do not have an insurable interest without canceling the policy. Thus, the year-end agreement and grant of security interests in the policies to LT Funding did not interfere with the validity of the policies in purchase.

However, the IRS argued that the step transaction doctrine applied to effectively strike down the transactions, treating LT Funding as the original purchaser of the policies. As an unrelated third party, LT Funding does not have an insurable interest in Larry's life policy. If treated as the original purchaser, the transaction would be void under the insurable interest rule. If so, the trust would have a claim against LT Funding to recover the proceeds paid under the agreement. This right of recovery would be an asset of the estate, included under section 2031.

Several common law tests are used to determine whether the step transaction doctrine applies. The doctrine is essentially a variation of the “substance over form” argument, according to which the IRS asserts that the mechanical form of a series of transactions should be taxed as a collective transaction.

Under the “end result” test, if the taxpayer's subjective intent indicates that the series of transactions was predetermined to achieve a certain end result, the transaction will collapse. The court found no evidence that Larry or the trust intended to transfer the policies to LT Funding when they were originally purchased.

According to the “interdependence” test, the court will overturn the series of transactions if some steps are so interdependent that they would have no legal effect or meaning without completing the other steps. The court found that the purchase and transfer of the trust also did not apply here because the original purchase of the insurance policies for estate tax purposes was not meaningless without the LTF Agreement, noting that the premiums were paid for 30 months. Even if additional funds were later required, the initial purchase provided the trust with a $20 million benefit on Larry's death over the next 30 months.

Because the original purchase was proper under Maryland law and the court ruled that the step transaction did not apply, the trust had no claim against LT Funding that would be included in the estate.

• Inflation adjustments for 2025 are announced—In Revenue Ruling 2024-40 (October 22, 2024), Treasury published the inflation adjustments for 2025. Estate planners should consider the new exemption and exclusion amounts:

• Gift, estate and generation transfer tax exemption amounts: $13.99 million (up from $13.61 million).
• Annual gift tax exemption (IRC Section 2503): $19,000 (up from $18,000).
• Top income tax bracket (37%) for estates and trusts: $15,650 (up from $15,200).
• Zero percent capital gains tax bracket for estates and trusts: $3,150.
• Annual exemption gift for noncitizen spouse: $190,000 (up from $185,000).