The Estate of Morrissette and Split-Dollar Agreements
Estate of Morrissette v. United States eliminated a significant challenge advanced by the Internal Revenue Service to the use of intergenerational split-dollar arrangements (“SDAs”). Morrissette has been lauded as giving practitioners freedom to structure intergenerational SDAs without fear of immediate gift tax consequences, but practitioners must remember that the Morrissette holding is limited. Holland & Knight private wealth attorneys J. Alan Jensen and R. Brent Berselli implemented a similar SDA and defended the arrangement before the United States Tax Court, ultimately reaching a favorable settlement with the Internal Revenue Service. In this LISI Estate Planning Newsletter, they provide commentary on Morrissette and the arguments that the IRS will likely continue advancing to combat perceived “abusive” arrangements:
Economic Benefit versus Loan Regime
- Determination of the loan regime of IRC §7872 versus the economic benefit regime hinges on ownership of the insurance policy subject to an SDA. In Morrissette, the donee-Dynasty Trusts were the record owners of the insurance policies; however, the Treasury Regulations provide an ownership exception where, assuming the only benefit provided to the donee is current life insurance protection, the donor is the deemed owner of the policies.
- The insurance policies at issue in Morrissette were structured for payment of a single, lump sum premium. The Service sought to apply the loan regime of IRC §7872, rather than the economic benefit regime, to govern the tax treatment of the SDAs on the theory that the single premium conferred some additional benefit to the donee above current life insurance protection.
- The Court correctly ruled that the economic benefit regime applied to the Morrissette SDAs because the donee-Dynasty Trusts, at all times, received only current life insurance protection in any given year. The fact that the SDAs were structured to require a single, lump sum insurance premium did not provide an additional benefit to the donee other than current life insurance protection.
Morrissette has resolved the economic benefit versus loan regime determination in a single premium intergenerational SDA; however, we anticipate the IRS will continue to advance the following arguments to contest the legitimacy of an SDA:
That the SDA is a sham transaction and lacks a justified business purpose. The Service will likely assert either that the donor received inadequate consideration or that the sole purpose of the SDA was tax avoidance. Documenting a non-tax business purpose is critical to combat this argument.
That the decedent is treated as gifting the life insurance policy to the donee under the step-transaction doctrine. Counsel should closely adhere to the Treasury Regulations in structuring SDAs to bolster the defense to a step-transaction claim.
Consistency and Valuation
- In a typical SDA, the decedent-donor will have limited access to the cash surrender value of the insurance policy, and likely will only be repaid advanced premiums upon the death of the insured or mutual termination of the SDA. The Service is likely to assert that, under IRC §2703, the donor-decedent’s restricted access to the cash surrender value should be disregarded. IRC §2703 disregards certain rights and restrictions in valuing an asset. However, if an SDA is properly structured, IRC §2703 should be inapplicable in valuing the SDA receivable owed to the decedent-donor’s estate.
- Assuming the restrictions on the decedent’s ability to access cash surrender value are contained in the SDA, itself, IRC §2703 should not apply because the SDA is not valued on the decedent-donor’s estate tax return. Rather, the receivable owed to the decedent’s estate is the relevant asset subject to valuation. Often, the receivable will contain no restrictions on transfer, and the decedent-donor could freely dispose of the receivable.
- We suspect that valuation will continue to be the significant issue in Morrissette. Due to the amount at stake, we suspect that the taxpayer and the Service will reach a settlement on valuation of the SDA receivable. In our similar litigation, the IRS appellate conferee analogized the valuation of an SDA receivable to that of a family limited partnership holding cash or marketable securities.
Read the full article: Estate of Morrissette: Unfinished Business