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D. The problems of policy ownership

D. The problems of policy ownership.

The proper ownership of life insurance is critical to avoiding a variety of unwanted tax consequences. Attorney George M. Turner of California, a respected authority, has estimated that insurance is improperly owned in the large majority of cases, from the tax planning point of view. The situation can be more complicated than it appears.

For example, a major advantage of life insurance is the (generally) income tax-free receipt of proceeds by the beneficiary. This is widely known to the public, and we have mentioned how to avoid estate taxation, as well, on these proceeds upon your death. (An irrevocable Trust can be used to buy and own the policy, to avoid estate taxation. More later.) But without comprehensive planning, the usefulness of these features can easily be lost.

BEWARE ! Visions from “Tax Hell:”

1) Mom owns a life policy on Dad, with the children as beneficiaries. She is careful to pay premiums with her own separate funds, so that Dad won’t somehow be deemed by IRS to have strings attached (more on this later), and the proceeds, therefore, will not be included in his taxable estate.

At Dad’s death, the insurance money goes directly to the children, exactly as planned. No estate tax is due. BUT, Mom has made a taxable gift to the kids, for federal purposes, because she “gave” them the policy proceeds! And if the kids put up part of that money to help Mom with the gift tax – if any is actually due and payable – then they will be deemed to have made a taxable gift to Mom!!

2) Beware, business owners, of a common arrangement: A policy on the life of a stockholder (or key employee) is payable to his/her beneficiary, but owned by the corporation, which has paid all premiums. There are a variety of undesirable tax consequences possible, depending on the specific facts of the case. For example, such life insurance proceeds may be includable in the decedent’s final income tax return as “income in respect of a decedent.” Anything left after income tax might be considered part of the taxable estate!

Fortunately, there are strategies for dealing with these insurance needs in a tax-efficient way, but they are beyond the scope of this book. The tax laws applicable to life insurance are exceedingly complex. The essentials can be explained easily enough, however, once you find a trusted insurance agent, from a good company, who is experienced with the concerns and needs confronting you.

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