The Edmond Sun

January 11, 2013

ASK A LAWYER: Estate tax may hit life insurance

Matt Hopkins
Ask A Lawyer

EDMOND — EDITOR’S NOTE: This is a weekly series of columns written by attorneys at Lester, Loving & Davies law firm in Edmond. This week’s column is part one of two about the possible taxation of life insurance.



Q: Will my children have to pay taxes on my life insurance proceeds?

A: In a previous article, we established that life insurance proceeds are not generally subject to income tax. We also advised that life insurance proceeds generally become part of the taxable estate of the decedent, and therefore subject to estate tax.

Is there a way to make life insurance proceeds free from estate taxation? This discussion must start with a disclaimer. When it comes to the application of tax laws at a future time, very little certainty is possible. Tax implications are extremely fact sensitive and general rules are difficult to accurately state. You should seek the advice of a qualified tax professional or attorney to design your estate plan — including life insurance elements — in a way that is most likely to create available tax savings.

Life insurance proceeds become part of your taxable estate — and therefore potentially subject to taxation — if you were the owner of the policy or your estate is the beneficiary of the policy. So, conversely, the opposite is generally true. If you do not own the life insurance policy, and your estate is not the policy beneficiary, the life insurance proceeds should be free of estate tax.

But things get complicated from here. If you hold any “incidents of ownership” over the policy you are deemed to be its owner, even if it is titled in another's name. If you retain control over any element of the policy, you are deemed to have owned the policy, and the proceeds become part of your estate. Moreover, if the benefits are payable to a person or entity other than your estate, but the recipient is directed to pay certain estate expenses with the proceeds, your estate can be the deemed beneficiary, making the benefit taxable.

Two common practices seek to remove life insurance proceeds from estate taxation. First, you may elect to make your spouse, children or business partners the owners of your policy. As long as you retain no control over the policy or other incidents of ownership, the benefits will not become taxable. You can even pay the premiums personally. Second, you can set up an irrevocable insurance trust to hold your policy. Both practices are tricky and numerous standards must be met to keep the proceeds tax free. Again, you should seek the advice of a tax professional before designing your life insurance plan.    



MATT HOPKINS is an attorney for Lester, Loving & Davies P.C. More information is available at lldlaw.com. Send questions to questions@lldlaw.com.