On February 28, 2022, the Tax Court issued the full opinion in Estate of Levine v. Commissioner (158 T.C. No. 2). The primary issues presented in Estate of Levine v. Commissioner were

1. whether the taxpayer made a voluntary inter vivos transfer (yep);
2. whether the taxpayer retained the right—either alone or in conjunction with her attorney-in-fact—to designate who could possess or enjoy property transferred to irrevocable life insurance trust or the income from it (thereby precluding inclusion of cash-surrender values of policies in taxpayer’s estate) (nope);
3. whether the taxpayer had a unilateral power to terminate split-dollar life insurance policies held by irrevocable trust (thereby precluding inclusion of policies’ cash-surrender values in gross value of taxpayer’s estate for estate tax purposes) (nope and nope); and
4. whether IRC § 2703 (disregarding restrictions on right to sell or use property in determining its value) applied (no ma’am, Marion, it did not).

Estate of Levine v. Commissioner in a Nutshell

The decedent, Marion Levine, entered into a complex transaction in which her revocable trust paid premiums on life-insurance policies taken out on her daughter and son-in-law that were held by a separate and irrevocable life-insurance trust. Levine’s revocable trust had the right to be repaid for those premiums. Levine has since died, and the question is what has to be included in her taxable estate because of this transaction—is it the value of her revocable trust’s right to be repaid in the future, or is it the cash-surrender values of those life-insurance policies right now?

The Tax Court considered aspects of similar transactions both in Estate of Morrissette v. Commissioner,^[1] and in Estate of Cahill v. Commissioner,^[2] but in this one, the Tax Court was faced with “novel questions” of how to decide what the revocable trust transferred before Levine’s death and what it held when she died.

Background to Estate of Levine v. Commissioner

Levine was born in St. Paul, Minnesota in 1920. She lived there with her nine brothers and sisters through the Great Depression until she married George Levine. They were of the Greatest Generation, and Levine followed her new husband as best she could even after he was drafted into service. He served honorably, and when Uncle Sam had won,^[3] they made their way back to St. Paul.

They “enlisted together in the ensuing baby boom,” and had two children—Nancy and Robert. Nancy had three children— Scott, P.J., and Jonathan—with her husband Larry Saliterman. Robert has two sons, too—Charles and Michel. George died in 1974, and after a brief dalliance with Henry Orenstein “sometime in the 1980s,” Levine married Harold Frishberg around 1990, and they remained married until his death in 2005.

Levine graduated from high school and received some business-school training, but never earned a college degree. At a time when it was especially unusual, she nevertheless became a highly successful businesswoman. Her success began in 1950 when the Levines opened Penny’s Supermarket.

This small family business eventually grew to a 27-store, multimillion-dollar company. Levine did almost everything at Penny’s—she collected timecards, oversaw payroll, paid bills, and tracked inventory. She became the sole boss after George died, until after more than three decades of minding the store, she sold the business for $5 million in 1981.

The proceeds did not become a nest egg for a comfortable retirement; Levine used them instead as capital to hatch new businesses that increased her net worth to $25 million over the next twenty years.

Judge Holmes—my judicial hero—noted that none of these new businesses had anything to do with groceries. They were real-estate investments, a stock portfolio that she had begun in the early ’60s and tended herself, interests in two Renaissance fairs, several mobile-home parks, and loans to real-estate partnerships and mobile-home park residents.

Most of Levine’s real-estate investment activity was as a lender. Levine—along with her son-in-law, Larry, her son Robert, and her “close personal friend” Bob Larson—created two companies named 5005 Properties and 5005 Finance to manage all the real-estate ventures. Bob, Larry, and Robert managed the day-to-day business for these properties, while Levine mostly supplied the financing.

One of Levine’s biggest and most profitable assets in her real-estate portfolio was Penn Lake Shopping Center, LLC (Penn Lake). She and her late husband had built Penn Lake in 1959, and by 2007 the property was free of debt and produced approximately $200,000 in annual income.

Levine owned several mobile-home parks through 5005 Properties. This business began in 1979 when she bought a mobile-home park in Dayton, Minnesota. These investments settled into a simple pattern: 5005 Properties would buy the property and rent spaces to residents.

At the height of this business, 5005 Properties owned 30 mobile-home parks, but its portfolios had shrunk. Banks had stopped financing mobile homes after enactment of reform legislation, so 5005 Finance itself stepped in and got extra revenue from lending to prospective residents.

Levine also began to invest at some point in Renaissance fairs. And now, enter Judge Holmes, stage left:

[Renaissance fairs] are a bit like state fairs, if the state were a small principality in fifteenth-century Europe populated entirely by modern people who enjoy costumed role-playing and adding extra “e’s” to words like “old” and “fair.”

And so, Judge Holmes begins his beautiful mockery of ye olde Renaissance Fairs…

There are 20 major Renaissance fairs around the country, and 5005 Properties owns and runs 2 of them—the Arizona and Carolina Renaissance Festivals (the latter in North Carolina). Levine entered the business in 1988 and her festivals were generally open 7-8 weekends a year. Each festival is a small business. 5005 Properties charges admission, sells food and drinks for all concessions, contracts with skilled craftsmen and entertainers, and buys advertising to make it all profitable.

Nancy, for the most part, was not active in the family businesses. Her brother Robert, on the other hand, became deeply involved early on and remains so today. He graduated from the Wharton School of Business. He then received his J.D. from the University of Colorado Law School in 1977. Judge Holmes, with a modicum of approbation, notes that Robert “seems to have inherited his parents’ business acumen” and that “he is an astute manager of the Levine family’s investments” at 5005 Properties.

As the turn of the millennium neared, Levine began to plan for her own old age. She gave both of her children a statutory power of attorney in 1996 to take care of her affairs if something happened. But Nancy and Robert have not always gotten along, so Levine thought it was necessary to have a third attorney-in-fact to play the referee. This role was played by Bob Larson. Levine drafted these powers of attorney; if there were any disagreements among the three attorneys-in-fact, the decision of the majority carried the day.

Bob is a Vietnam-era Marine who earned an accounting degree in 1966. He was working two different accounting jobs when his career—and his life—changed after meeting Levine in 1969. Bob’s wife was Levine’s hairdresser, and the Larsons got invited to Nancy and Larry’s wedding.

After meeting Levine at the wedding, Bob ran into her again while she was getting her hair done at his wife’s salon. Levine told Bob that she needed an in-house controller for Penny’s, and he should consider interviewing for the job. It all worked out very well. Bob won the position and began a 50-year professional and personal relationship. Bob’s role grew with the family’s businesses, and he has stayed on with 5005 Properties and 5005 Finance, where he is president of both. He oversees the tax and accounting work for the companies, and he signs most of the companies’ tax returns.

Levine’s “contemplated her mortality,” but she continued to manage her own legal affairs and stayed involved in the businesses. In 2003, however, she suffered a stroke while on vacation in Palm Springs. In 2004 or 2005 Robert and Nancy became concerned about her driving skills. They arranged for her to take a driver’s test, and her driver’s license was taken away. At this time, Levine remained involved in the business, but she worked less and less. In 2008, signs of dementia began to appear.

Levine’s Estate Planning

Well before any of these health issues arose, Levine began to plan her estate. She first created a revocable trust—the Marion Levine Trust—in May 1988. Levine was the trustee; she named Bob, Robert, and Nancy as successor trustees; and Nancy, Robert, and their children as beneficiaries.

She amended this trust agreement in May 1996 to add Bob, Robert, and Nancy as cotrustees. Then, in February 2005 she resigned as trustee and made Bob, Nancy, and Robert the sole cotrustees at about the same time as she signed the short-form power of attorney described above.^[4]

Between 1996 and 2007 Levine used an attorney named Bill Brody to do her estate planning. Her family persuaded her to find a new (more advanced) attorney, and Shane Swanson, an attorney at Parsinen Kaplan Rosberg & Gotlieb, P.A. (Parsinen), was selected and retained in November 2007 to review and revise Levine’s estate plan. Swanson was the primary point of contact for Levine and her attorneys-in-fact, and he took the lead on the estate-planning work.

Swanson first worked with Levine to make sure all her business entities both were properly structured and meshed well with a comprehensive estate plan. Swanson was able to either update or restructure the partnerships that Levine controlled directly into more modern entities such as LLCs.

Swanson also created different trusts to hold some of Levine’s real-estate assets which allowed her to pass them to her children in ways that would produce estate-tax savings. He wasn’t looking to do anything radical and started by using two tools well known to estate planners: the grantor retained annuity trust (GRAT) and the qualified personal residence trust (QPRT).

A GRAT is a “tax-saving device in which a grantor transfers assets into trust and retains an annuity payable for a specified term.”^[5] When these GRATS are structured according to the Code, the transferor avoids incurring any gift-tax liability.^[6] If the grantor survives to the end of the specified term, any appreciation in the asset’s value over the rate specified in IRC § 7520 passes to the beneficiaries without any gift or estate tax.^[7]

If the grantor does not survive, however, the full value of the asset is included in her gross taxable estate.^[8] This GRAT structure is specifically provided for in the regulations under special valuation rules.^[9] Levine placed her Dayton Park project partnership—located in Dayton, Minnesota—into the GRAT with a two-year term, with any appreciation on the asset to pass to Nancy and Robert at the end of this term.

A QPRT allows an individual to transfer her home into a trust, which makes it exempt from estate and gift taxes so long as the transferor uses the home as her personal residence for the specified term.^[10] Levine placed 50% of her Minneapolis condo into a QPRT with a two-year term, and the other 50% in a different QPRT with a three-year term.

During these terms, she was able to live in her condo rent free, but after the terms expired, title would pass to Nancy and Robert. If Levine wanted to continue to live in the condo, she would at that point be required to pay fair market rent to them to do so. A QPRT can reduce the value of the property it holds by an amount equal to the value of the right to live in it for the trust’s term, which would also reduce potential estate tax.^[11]

From the beginning, Bob and Levine’s children made it clear to Swanson that Levine wanted enough money to maintain her lifestyle until her death. This meant that any estate planning needed to be done with Levine’s excess capital (i.e., assets that she would not likely need during her lifetime). This was especially difficult because so much of Levine’s wealth was in real estate or partnerships that owned real estate.

She owned a number of properties that were unencumbered by any debt—her condo in Minneapolis, a home in Rancho Mirage, California, her interests in the mobile-home parks and the two Renaissance fairs, and the Penn Lake Shopping Center. Levine wanted these assets to stay in her estate so that her children would inherit them with stepped-up bases when they passed to her children.

But, like a halberd, stepped-up basis cuts both ways.^[12]

Bless you, Judge Holmes. Thy wit is as sharp as a rapier…or, I suppose, a keenly sharpened halberd.

Holding onto real estate might cut future capital-gains tax, but it also meant that its value would be part of Levine’s gross taxable estate. Swanson typically used insurance to help clients prepare to pay the estate tax that would eventually be due on these relatively illiquid investments.

He suggested to the children (and Bob) that there might be a way for Levine to invest her excess capital to provide her with a good return, while at the same time meshing with the Levine children’s needs for estate plans of their own. His idea: intergenerational split-dollar life insurance.

Planning the Split-Dollar Life-Insurance

While Swanson had done a split-dollar insurance arrangement before, he had never done a transaction like the one he was proposing for Levine—loans from a parent to her children to buy life insurance for them. He explained that the circumstances that might make this type of transaction attractive are very rare, and require that the client

• has enough cash to buy a substantial amount of life insurance, and to live on for the rest of her life;
• faces an estate-tax bill large enough to justify the costs of planning and execution;
• has children whose lives would be insured, and who themselves have a sufficient net worth to qualify for large life-insurance policies; and
• has children who are healthy enough to navigate the underwriting process successfully.

Swanson presented his idea to the family in late 2007 or early 2008. In January 2008 he sent a letter to Bob and the children in which he described the transaction and its legal and tax implications.

He told them that Levine could contribute money to a trust that would be for the benefit of Robert, Nancy, and her grandchildren. Its trustees would then use the money to buy life-insurance policies on Nancy and Robert’s lives. This would not be purely a gift—the trust would get Levine’s money only in exchange for a promise by the trust to pay her the greater of the money she advanced, or the cash value of the policies upon the earlier of the insureds’ deaths or the policies’ surrender.

The right to this repayment would be held by Levine as a “receivable”—in other words, it would be an asset that the Estate reported on its estate-tax return. His proposal assumed that Levine would lend the trust enough to pay $10 million in premiums, but he said that the technique could be used at any premium level depending on the insured’s insurability—i.e., “proof of good health of the insured.”^[13]

Swanson’s proposal was complex, and the Tax Court believe the testimony of Levine’s children and Bob that, even though they each received a copy of this detailed proposal letter, they actually learned more about the transaction and finally understood it better through Swanson’s discussions with them.

Ultimately, Levine personally approved the transaction, but limited the amount that she was willing to lend to the trust for premiums to $6.5 million. Levine thought that she had done enough for her kids and wanted to make sure that she could take care of her grandchildren.

Establishing the Irrevocable Life-Insurance Trust

Irrevocable life-insurance trusts are typically used as a vehicle to own life-insurance policies to reduce gift and estate taxes.^[14] Levine’s Insurance Trust was signed at the end of January 2008 by her children and Bob as attorneys-in-fact and the South Dakota Trust Company, LLC (South Dakota Trust) as an independent trustee. The Insurance Trust’s beneficiaries were Robert, Nancy, and Levine’s grandchildren—the grandchildren that Levine naturally wanted to take care of.

South Dakota’s laws are favorable—no rule against perpetuities, a taxpayer-friendly state income tax, and a favorable premium tax. It is also one of the few states with a “directed” trustee statute, which allows the separation of management and administration of a trust’s investments.^[15] Levine’s Insurance Trust named South Dakota Trust as its directed trustee. This put South Dakota Trust in charge of administration—opening up trust accounts and handling them according to the terms of the trust document.

South Dakota Trust, however, was only the administrator—it had no authority to choose what the trust would invest in. Swanson drafted the trust to have trustees whose job it would be to direct its investments. This was the “investment committee,” and its membership consisted of one person—Bob.

Levine picked Bob for this role because he had long been very close to the Levine family yet was not a part of it. Levine knew the relationship between her children was fraught. She wanted someone she could trust to manage not just the trust but the relationship—and her children understood this. Bob has been the sole member of the investment committee since it began.

South Dakota law defines this committee’s fiduciary obligations to the Insurance Trust and its beneficiaries.^[16] And the Tax Court specifically found that, as the committee’s only member, Bob was under a fiduciary duty to exercise his power to direct the Insurance Trust’s investments prudently, and he faced possible liability to its beneficiaries if he breached that duty. Bob approved the split-dollar life-insurance arrangement on behalf of the Insurance Trust in his role as the investment committee.

Acquiring the Life Insurance Policies

Ultimately, it was decided that the Insurance Trust would buy two last-to-die policies with John Hancock and Pacific Life on the lives of Nancy and her husband Larry. Swanson and Levine’s children decided to borrow money to fund these life-insurance premiums. Levine and her children wanted to lock in the quoted premium rates for the policies, so they quickly took out short-term loans to do so—some taken out by Levine’s real-estate partnerships.

With the exception of the Central Bank loan, the loans were expected to be quickly repaid by refinancing the debt on the partnerships, as well through the sale of the Arizona Renaissance Festival. Thus, almost all of the $6.5 million came via loans.

The first loan was $3.8 million from Central Bank to Penn Lake. Levine and her children planned to pay the loan’s interest, which they’d been advised would increase Levine’s basis in the receivable that the Estate would be obtaining as part of this split-dollar transaction. Levine’s estate would eventually owe tax on what it got back from the Insurance Trust through the receivable the Estate held, and that tax would shrink if Levine’s basis in the receivable increased.

The children and Bob also opened a personal line of credit with Private Bank of Minnesota. This gave Levine access to $2 million for a term of one year at 5.25%. Any outstanding balance was due and payable in a single balloon payment in thirteen months. They secured this line of credit with various properties and assets that Levine Investments, 5005 Properties, and 5005 Finance owned.

The last of the three loans was arranged by Nancy and Robert in their capacities as cotrustees of Levine’s Revocable Trust. It was with Business Bank for $516,000 at an annual rate of 6.9%, with monthly payments of $4,000 over the course of 5 years, followed by a balloon payment of any unpaid principal and interest at the end of that term. They secured it with the Revocable Trust’s interests in several installment-sales contracts and leases.

They ultimately wired $4 million from Penn Lake to Pacific Life to pay the one-time premium for the whole-life policy with a face value of $10,750,000 on the lives of Nancy and Larry. It will pay out after both of their deaths. A few days later, $2 million was wired to John Hancock, and a month later, another $500,000 was wired. This paid the one-time premium for another last-to-die whole-life policy, this one for $6,496,877. Both polices had cash-surrender values that were guaranteed to increase by at least 3% per year.

Levine’s Split Dollar Arrangement

Between June and July 2008, Nancy, Robert, and Bob—in their capacities as Levine’s attorneys-in-fact and as trustees of her Revocable Trust—executed several documents to put the split-dollar arrangement into effect:

• The Insurance Trust agreed to buy insurance policies on the lives of Nancy and Larry;
• The Revocable Trust agreed to pay the premiums on these policies;
• The Insurance Trust agreed to assign the insurance policies to the Revocable Trust as collateral;
• The Insurance Trust agreed to pay the Revocable Trust the greater of (i) the total amount of the premiums paid for these policies—$6.5 million—and (ii) either (a) the current cash-surrender values of the policies upon the death of the last surviving insured or (b) or the cash-surrender values of the policies on the date that they were terminated, if they were terminated before both insureds died.

It was very important, if this deal was to work, that the Insurance Trust and not the Revocable Trust own the policies. The recitals in the arrangements state that the parties do not intend to convey to Levine or the Revocable Trust any “right, power or duty that is an incident in ownership…as such is defined under [IRC § 2035 and IRC § 2042]” in the life-insurance policies at the time of Levine’s death. Further, neither the Insurance Trust, nor its beneficiaries, nor the insureds—Nancy and Larry—would have access to any current or future interest in the cash value of the insurance policies.

There were two split-dollar arrangements, one for each insurance company. The Tax Court specifically found that in both arrangements, only the Insurance Trust—meaning Bob—had the right to terminate the arrangements. Paragraph 6 from both arrangements controlled the right to terminate the arrangements:

The Insurance Trust shall have the sole right to surrender or cancel the Policy during the lifetime of either insured. In addition the Insurance Trust may terminate this Agreement in a writing delivered to the other party, effective upon the date set forth in such writing.

If the Insurance Trust did terminate the Agreement, however, it would get nothing:

The Revocable Trust shall have the unqualified right to receive the total amount payable upon such surrender or cancellation of this Policy, or upon termination by notice from the Insurance Trust, and the Insurance Trust shall not have access to, or any current or future interest in, the Cash Value. Upon such payment of said funds to, and receipt of said funds by, the Revocable Trust, this Agreement shall terminate.

With the split-dollar deal done, Swanson had finished “hammering into place the paper armor” he had designed to protect as many of Levine’s assets from tax as he legally could.

Brilliant.

Tax Reporting

Swanson prepared gift-tax returns for 2008 and 2009. Bob and Nancy signed these returns in their capacities as Levine’s attorneys-in-fact. Each Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, reported the value of the gift as the economic benefit transferred from the Revocable Trust to the Insurance Trust.

Gifts of valuable property for which the donor receives less valuable property in return are called “bargain sales.”^[17] The value of gifts made in bargain sales is usually measured as the difference between the fair market value of what is given and what is received.^[18] The IRS, ‘for whatever reason,” issued regulations that provide a different measure of value when split-dollar life insurance is involved.^[19] The number Bob and Nancy came up with after applying the valuation rules in the regulations was $2,644.^[20]

Everyone involved also knew that the promise of the Insurance Trust to pay the Revocable Trust some amount sometime in the future was also valuable. On Levine’s estate-tax return—specifically Schedule G, Transfers During Decedent’s Life, of the Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, the value of the split-dollar receivable, as owned by the Revocable Trust on the alternate valuation date, was reported as an asset worth about $2 million.

Audit and Trial

This shift of money from the Revocable Trust for the purchase of the life-insurance policies that benefited the Insurance Trust caught the IRS’s attention.

The IRS issued its challenge, and the joust between the IRS and the Estate began.

The IRS noticed two things in particular. The first was the small amount—only $2,644—that Levine reported as the gift that her Revocable Trust had made to the Insurance Trust. The second was that the Insurance Trust had promised to pay the Revocable Trust the greater of $6.5 million or the policies’ cash surrender value at either the death of both Nancy and her husband or upon termination of the policies.

At the time of Levine’s death, this value was close to $6.2 million, and the IRS suspected there was no insurmountable hurdle to the Insurance Trust’s terminating the policies well before Nancy and her husband both died. This would mean that the Insurance Trust and Levine’s descendants, as beneficiaries of the Revocable Trust, had ready access to $6.2 million, not just the $2.1 million + $2,644 that was reported on the estate and gift-tax returns.

The IRS assigned as its jousting “champion” estate-and-gift-tax attorney Scott Ratke, who conducted an extensive audit, and in the end the IRS issued a notice of deficiency to the Estate for slightly more than $3 million. This reflected several adjustments, but his adjustment to the value of Levine’s rights under the split-dollar arrangement was by far the biggest.

He also determined that the Estate was liable for a 40% gross-misvaluation penalty under IRC § 6662(h) because the value that it had reported for the split-dollar receivable was way too low. Ratke prepared a penalty-approval form for this penalty, which was signed by his immediate supervisor at the time before the notices of deficiency were sent. Counsel for the parties worked together to narrow the issues “so their combat could be confined to a small tilt and not become a general melee.”

Three stipulations settled most issues. Only two remain:

• Was the value of the split-dollar receivable in Levine’s estate on the alternative valuation date $2,282,195, or the policies’ cash-surrender value of $6,153,478?
• Is any resulting underpayment subject to the 40% gross-misvaluation penalty under IRC § 6662(h)?

Analysis: Split Dollar Life Insurance

Split-dollar life-insurance deals began as a form of employment compensation. Employers wanted to pay the premiums on life insurance for their employees, keep an interest in the insurance policy’s cash value and death proceeds, and pass on to the employee—or the employee’s designated beneficiary—any remaining death benefit.^[21]

The “split” in “split-dollar” refers to this division of the insurance proceeds between the insured and the person or entity that paid the premium. In 1964, the IRS issued Rev. Rul. 64-328, in which it announced that it would include the death-benefit portion of a life-insurance policy in a recipient’s income because it was an economic benefit.

Split-dollar arrangements eventually became a tool for estate planners who aimed to remove death benefits from their clients’ taxable estates—or at least defer payment of any tax owed. This is attractive because of “some unusual advantages” that the Code gives to buyers of life insurance—especially on what is called “inside buildup.”

An insurance company can sell a policy with premiums much larger than one would pay for term insurance. This money can go to work for the policyholder or her beneficiaries and “build up” as long as the policy remains in effect. It can make for a much larger death benefit or a substantial cash surrender value.

Unlike income earned on other savings accounts-such as bank CDs or mutual funds—inside buildup is not taxed under IRC § 72(e) as it accrues. It is eventually taxed when it is distributed to the policy holders,^[22] but that can be a long time into the future, and all other things being equal, tax tomorrow is better than tax today—“and tax decades from now is better still.”

Over the years, the IRS provided limited guidance on the taxation of split-dollar life-insurance arrangements, mostly in the form of notices and revenue rulings. That all changed when the Treasury Department issued the final regulations contained in Treas. Reg. § 1.61-22 in 2003. These govern all split-dollar arrangements entered into or materially modified after September 17, 2003.

The final regulations broadly define a split-dollar life-insurance arrangement between an owner and a nonowner of a life-insurance contract in which:

• either party to the arrangement pays, directly or indirectly, all or a portion of the premiums;
• the party making the premium payments is entitled to recover all or a portion of those premium payments, and repayment is to be made from or secured by the insurance proceeds; and
• the arrangement is not part of a group-term life insurance plan (other than one providing permanent benefits).^[23]

The split-dollar arrangement in this case meets these specific requirements.

The regulations create two different and mutually exclusive regulatory regimes—called the “economic benefit regime” and the “loan regime.” These regimes govern the income- and gift-tax consequences of split-dollar arrangements. Which regime a particular arrangement falls under depends on who “owns” the life-insurance policy at issue.^[24]

The general rule is that the person named as the owner is the owner.^[25] Nonowners are any person other than the owner who has a direct or indirect interest in the contract.^[26] Under this general rule, the Insurance Trust would be the owner of the policies here, and the loan-regime rules would apply. However, there is an important exception to the general rule.

If the only right or economic benefit provided to the donee under a split-dollar life-insurance arrangement is an interest in current life-insurance protection, then the regulations ignore the formal ownership designation and treat the donor as the owner of the contract. This is the economic-benefit regime.^[27] This presents a threshold question as to whether the Insurance Trust received any economic benefit in addition to current life-insurance protection.

In Morrissette I,^[28] the Tax Court held that a split-dollar arrangement much like this one fell under the economic-benefit regime for gift-tax purposes. However, the Tax Court also noted in Morrissette I,^[29] that “the Tax Court was not deciding whether the estate’s valuation of the receivables…in the gross estate [was] correct.” What’s more, Treas. Reg. § 1.61-22(a)(1) seems not to cover the estate-tax consequences of split-dollar arrangements at all.

The final regulations do make one reference to estate tax in their preamble. Specifically, the preamble states “[f]or estate tax purposes, regardless of who is treated as the owner of a life insurance contract under the final regulations, the inclusion of the policy proceeds in a decedent’s gross estate will continue to be determined under IRC § 2042.”^[30]

However, the express terms of IRC § 2042 limit its applicability to life-insurance policies on a decedent’s own life, not split-dollar arrangements where policies are taken out on the lives of others.^[31] Thus, the Tax Court concluded in Morrisette I that neither Treas. Reg. § 1.61-22 nor IRC § 2042 governs the Tax Court’s valuation of the split-dollar arrangement the Tax Court has to analyze.

Thus, Judge Holmes found that the Tax Court was left “to look to the default rules of the Code’s estate-tax provisions to figure out how to account for the effect of this split-dollar arrangement on the gross value of this estate.”

Analysis: Estate Tax Generally

IRC § 2051 defines a “taxable estate” as the value of a decedent’s gross estate minus applicable deductions. A decedent’s “gross estate,” according to IRC § 2033, includes the value of any property that a decedent had an interest in at the time of her death. Some taxpayers reduce their estate-tax liability by making inter vivos transfers several years before death and pay a usually smaller tax on the transfer.^[32] IRC § 2034 through IRC § 2045 set forth all other property that is included in an estate.

Among these sections is IRC § 2036, which generally includes in a decedent’s taxable estate the value of property that she transfers if, after the transfer, she kept either possession of or the right to income from the property; or even if she kept a right—either alone or in conjunction with another—to designate who would receive possession of that property or its income.

IRC § 2038 generally claws back into a decedent’s estate the value of property that she transferred in which she retained an interest or right—either alone or in conjunction with another—to alter, amend, revoke, or terminate the transferee’s enjoyment of the transferred property. Both IRC § 2036 and IRC § 2038 include an exception for transfers that are “a bona fide sale for an adequate and full consideration in money or money’s worth.”^[33]

IRC § 2703 also instructs how to value property for gift, estate, and generation-skipping-transfer tax purposes. It states that under certain circumstances property must be valued without regard to any right or restriction relating to the property that would result in the property’s being valued at less than its fair market value.^[34]

The Parties’ Positions

The Estate argued that the only asset from the split-dollar arrangement that Levine’s Revocable Trust owned at the time of her death was the split-dollar receivable. Levine, the Estate contended, did not own, or have any other interest in, the life-insurance policies because those policies were owned by the Insurance Trust. Further, as the Estate also points out, the value of that receivable is a number that the parties have stipulated.

In the IRS’s view, this entire transaction was merely a scheme to reduce Levine’s potential estate-tax liability and, if it was a sale, it was not bona fide because it lacked any legitimate business purpose. The IRS argued that the Estate should have reported on its return the cash-surrender values of the life-insurance policies, not the value of the receivable. It reasoned that:

• under IRC § 2036 Levine retained the right to income—or the right to designate who would possess the income—from the split-dollar arrangement, and
• under IRC § 2038 she maintained the power to alter, amend, revoke, or terminate the enjoyment of aspects of the split-dollar arrangement,
• even if the full values of the life-insurance policies are not includible in Levine’s estate under IRC § 2036 or IRC § 2038, the restrictions in the split-dollar arrangement should be disregarded under the special valuation rules provided in IRC § 2703, which would force the Estate to include in its taxable value the full cash-surrender values of the policies.

Analysis: What Rights Were Transferred and Retained under IRC § 2036 and IRC § 2038

The Tax Court looked first at what rights the Estate, through the Revocable Trust, transferred and what rights it retained. The Tax Court agreed with the IRS that the two snippets of the Code that the Tax Court has to decrypt here are IRC § 2036 and IRC § 2038.

IRC § 2036(a) is a catchall designed to prevent a taxpayer from avoiding estate tax simply by transferring assets before she dies.^[35] The general rule of IRC § 2036 is simple—where a decedent made a transfer, but she held onto some specified “string,” the value of the transfer should be included in the decedent’s estate. IRC § 2036(a) specifically excludes bona fide sales for an adequate and full consideration in money or money’s worth.

Specifically, IRC § 2036(a) provides that the value of the gross estate “shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer…by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death

1. the possession or enjoyment of, or the right to the income from, the property, or
2. the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.

IRC § 2038 also speaks of transferred “property,” and it includes in the gross value of an estate all property:

To the extent of any interest therein of which the decedent has at any time made a transfer…by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power…by the decedent alone or by the decedent in conjunction with any other person…to alter, amend, revoke, or terminate, or where any such power is relinquished during the 3 year period ending on the date of the decedent’s death.

The Estate argued that:

• it made no transfer of its property that could trigger these IRC §s,
• it retained no interest in the property that it did transfer, and in any event,
• the bona fide sale for adequate and full consideration exemption applies.

Analysis: What, if Anything, was “Transferred”?

Cases tell the Tax Court to define “transfer” broadly.^[36] “An IRC § 2036(a) transfer includes any inter vivos voluntary act of transferring property.”^[37] The scope of IRC § 2038, likewise imposes “a broad scheme” related to the transfer of “property.”^[38]

But what property? Here the parties disagreed.

• Is the property the Tax Court must look at the policies themselves?
• Is it the rights under the split-dollar arrangement to receive the greater of $6.5 million or the cash-surrender values of those policies?
• Or is it simply the $6.5 million in cash wired to the Insurance Trust from Levine’s assets before she died?

To the first point, the Tax Court found that the “property” at issue cannot be the life-insurance policies, as these policies have always been owned by the Insurance Trust. The split-dollar transaction was structured so that the $6.5 million was paid by the Revocable Trust in exchange for the split-dollar receivable. It was the Insurance Trust that bought the policies and held them. These policies were never owned by the Revocable Trust, and there was no “transfer” of these policies from the Revocable Trust to the Insurance Trust.

To the second point, the “property” also cannot be the receivable itself. That property belonged to the Revocable Trust and now it belongs to the Estate. It wasn’t “transferred.” It was retained.

That leaves the $6.5 million that Levine sent to the Insurance Trust from her assets that the Insurance Trust used to pay for the insurance policies. The Tax Court found that, through her attorneys-in-fact, Levine made a voluntary inter vivos transfer within the meaning of IRC § 2036(a) and IRC § 2038 when she wired $6.5 million to the life-insurance companies.

Judge Holmes observes that the IRS may not appreciate the quick disposition of the issue, noting that “from the IRS’s perspective, this is much too abbreviated an analysis.” Assuming his best Chuck Rettig voice, Judge Holmes states that the IRS would urge the court—“Don’t look at the money or the policies or the receivable.” Nay, good sir! “Look for that right to unlock the cash-surrender values of those policies.”

To be sure, such values may be defined by the terms of the life-insurance policies and thus defined by an arrangement between the Insurance Trust and the insurance companies in property that the Estate did not itself transfer. However, the Tax Court wonders aloud whether the right of the Revocable Trust (and now the Estate) under the split-dollar arrangement to receive those cash-surrender values somehow makes them includible in the Estate’s gross value…

Perhaps it might make sense, “were this the Tax Court’s first pass at the target,”^[39] to more simply analyze the problem. The Tax Court might just ask whether an estate that holds a split-dollar receivable has a right to a policy’s cash surrender value in its gross value directly—to ask first whether an estate has such a right and, if so, what its value is as of the date of death.

However, the Tax Court’s approach, as it has evolved, elides the questions of (i) whether this right was retained when the property creating it was transferred and (ii) whether it might somehow be exercised by the estate.

Analysis: Were Rights Retained?

The Treasury Regulations under IRC § 2036 instruct that “[a]n interest or right is treated as having been retained or reserved if at the time of the transfer there was an understanding, express or implied, that the interest or right would later be conferred.”^[40] The use, possession, enjoyment, right to income, or other enjoyment of property is considered having been retained or reserved “to the extent that the use, possession, right to the income, or other enjoyment is to be applied towards the discharge of a legal obligation of the decedent, or otherwise for his pecuniary benefit.”^[41]

If the Tax Court were right that the only property that Levine transferred was cash, then the Tax Court’s analysis under IRC § 2036 would seem to be easy—she retained no “interest” in that cash. She did, however, get something in return—the split-dollar receivable created and defined by the split-dollar arrangements.

The receivable gave her the right to the greater of $6.5 million or the cash-surrender values of the policies. Under the terms of the split-dollar arrangements, however, Levine did not have an immediate right to this cash-surrender value. She (or her estate) had to wait until the deaths of both Nancy and Larry, or the termination of the policies according to their terms.

Here the Tax Court found what could be a very important difference between the split-dollar arrangements in the Estate of Levine v. Commissioner case and those analyzed in Estate of Cahill and Morrissette II. In Levine’s case, the split-dollar arrangements between the Revocable Trust and the Insurance Trust expressly stated that only the Insurance Trust had the right to terminate the arrangement. The split-dollar arrangements the Tax Court analyzed in Morrissette II and Estate of Cahill were different.

Specifically, the language of the arrangement in Morrissette II stated that

The Donor and the Trust may mutually agree to terminate this agreement by providing written notice to the Insurer, but in no event shall either the Donor or the Trust possess the unilateral right to terminate this Agreement.

The similar arrangement in Estate of Cahill stated that

This Agreement may be terminated during the Insured’s lifetime only by written agreement of the Donor and the Donee acting unanimously. Such termination shall be effective as of the date set forth in such termination agreement.

As Judge Holmes rightly and curtly observes, “[t]his difference matters.”

Unlike in Morrissette II and Estate of Cahill, in Estate of Levine v. Commissioner, the Tax Court saw “a carefully drafted arrangement that expressly gives the power to terminate only to the Insurance Trust.” It further gave Levine, herself, no unilateral power, whatsoever, to terminate the policies and contained no language like that in the arrangement at issue in Estate of Cahill or Morrissette II that gave her that right acting in conjunction with the Insurance Trust.

By requiring both parties’ approval, the arrangements that the Tax Court analyzed in Morrissette II and Estate of Cahill necessarily required each decedent’s approval to terminate the arrangement. The opposite is true here, where only the Insurance Trust could terminate the arrangement.

Without any contractual right to terminate the policies, the Tax Court could not say that Levine had any sort of possession or rights to their cash-surrender values. “If the contest between the Estate and the IRS were confined to the tiltyard defined by the transactional documents,”^[42] the Tax Court would be compelled to conclude that IRC § 2036(a) and IRC § 2038 do not instruct the court to include the polices’ cash surrender values in the Estate’s gross value.

The IRS, however, tried to unhorse the Estate’s argument.^[43] It did so with the pointed assertion that the Tax Court should look at the transaction as a whole to get a clear picture of where each party stands and its role in the transaction. And that is exactly what the Tax Court did.

First, the Tax Court questioned whether its review of the rights that any decedent might keep in a split-dollar arrangement really should be defined by the documents alone. Then it looked carefully to the particular circumstances of the transaction in Estate of Levine v. Commissioner to determine whether, as a practical matter on the facts of this case, Levine kept a right to the cash-surrender values of the policies bought by the Insurance Trust.

As to the law, the Tax Court questioned if it should make a difference whether the transactional documents in a split-dollar arrangement put the unilateral right to unwind the transaction onto the donee rather than split it between the donor and donee. “First-year law students almost all learn that a black-letter rule of contract law is that the parties to a contract are free to modify it.”^[44]

Consequently, the IRS had a strong argument that this implicit power of parties to a contract is a “right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.”^[45] The IRS’s first pass at the Estate in this part of their joust would thus be something like this:^[46]

• The Estate is a party to the split-dollar arrangement with the Insurance Trust.
• The insurance policies belong to the Insurance Trust.
• The policies’ cash-surrender values are a form of income from that property.
• The right to the cash-surrender values belongs to the Revocable Trust (and thus the Estate) if the split-dollar arrangements are terminated.
• The arrangement may say that only the Insurance Trust has the power to terminate the deal and hand over that income to the Estate; however, general principles of contract law allow the Estate to modify any term of the arrangements in conjunction with the Insurance Trust.

The language of IRC § 2036(a)(2) is broad—it uses the word “right” without a modifier like “contract” or “instrument creating the.” So why should the Tax Court not construe “right” to include background rights like the right to modify a contract? Moreover, if it should, wouldn’t the cash-surrender values of the insurance policies be either a “right to the income” from that property under IRC § 2036(a)(1) or a right that could be exercised in “conjunction with” another to the income from that property under both IRC § 2036(a)(2) and IRC § 2038(a)(1)?

The problem for the IRS is Helvering v. Helmholz,^[47] a case about revocable transfers. Waldemar R. Helmholz was a widower, whose wife, Irene Cudahy Hemholz, had named him her sole heir.^[48] While she was alive, she settled valuable stock in a privately held corporation into a trust.^[49] Her brothers and sisters and her parents (sadly, but for her father Patrick Cudahy, we do not have the names of her siblings—I checked both lower courts’ opinions) were the other shareholders, and the trust corpus was destined for later descendants or, if her family line died out, to charity.^[50]

In her will, Irene left everything she owned at death to her dearest Waldemar.^[51] The IRS argued that settlors of a trust may, with the consent of its beneficiaries, terminate the trust and restore the contributed property to the settlors.^[52] Judge Holmes (again assuming Chuck Rettig’s vocal intonations) proposed that the IRS’s next question would be, “Dear Judge Holmes, is this not…‘a power, either by the decedent alone or in conjunction with any person, to alter, amend, or revoke’ a transfer of property?”^[53]

A “persnickety textualist” might quickly respond that it was. However, the Supreme Court is no such persnickety textualist.

Instead, the august judicial institution collectively looked at the text of the trust agreement itself and found that the test contained language that had express provisions for the trust’s termination—the death of the last surviving grandchild in the family, the written agreement of all the beneficiaries, a resolution by the directors of the family’s corporation, or the corporation’s liquidation.^[54]

The Court, therefore, characterized these express provisions for the termination of the trust as typical of “every welldrawn instrument.”^[55] The Court acknowledged that it was true that “a writing might have been executed by Mrs. Helmholz and her cobeneficiaries while she was alive, with the effect of revesting in her the shares which she had delivered into the trust.”^[56] Nevertheless, the Supreme Court held that

This argument overlooks the essential difference between a power to revoke, alter or amend, and a condition which the law imposes. The general rule is that all parties in interest may terminate the trust. The clause in question added nothing to the rights which the law conferred. Congress cannot tax as a transfer intended to take effect in possession or enjoyment at the death of the settlor a trust created in a state whose law permits all the beneficiaries to terminate the trust.^[57]

A more recent case that addresses the same problem is Estate of Tully v. United States.^[58] Edward S. Tully, Sr. owned half the stock in a private corporation.^[59] He and his partner, Vincent P. DiNapoli, reached an agreement long before his death that their company would pay a large death benefit to Edward’s widow, Pauline H. Tully and Vinny’s widow (not named, but we’ll call her Sophia).^[60] Tully died, and the government argued that the death benefit owed to Pauline from the corporation had to be included in his estate.^[61]

 

There was nothing in the instrument that gave Tully himself any interest in it at the date of death, but the government noted that he continued to own half his company till the day he died.^[62] The government reasoned that this meant that he had the power, acting with his partner Vinny, to do anything he wanted with corporate assets, and maybe he could have persuaded his partner to change the death benefit at any time.^[63]

“Nice try,” held the Court of Claims.

A power to “alter, amend, revoke or terminate” would trigger inclusion in an estate, but that kind of power “does not extend to powers of persuasion.”^[64] To be included within the Code’s sweep, a power has to be in the instrument itself, not a speculative possibility allowed by general principles of law. A broader reading, i.e., that a power to amend an instrument in conjunction with others includes all speculative possibilities, “would sweep all employee death benefit plans into the gross estates of employees.”^[65] This was not, the Court of Claims held, the intent of Congress.

The Tax Court encountered a somewhat similar argument in conservation-easement cases. Congress allows a deduction for such easements if done properly. One requirement of a proper easement is that it preserve land in perpetuity. Importantly, the parties to a contract can modify its terms, and easements are a kind of contract. The Tax Court rejected the IRS’s argument that a power to amend means that the parties might amend it so as to destroy perpetuity, which means that the easement wasn’t perpetual.

In so disagreeing, the Tax Court observed that “[g]enerally speaking, the parties to a contract are free to amend it, whether or not they explicitly reserve the right to do so.” However, “[t]he IRS’s argument would apparently prevent the donor of any easement from qualifying for a charitable contribution deduction under IRC § 170(h) if the easement permitted amendments.”^[66]

The Tax Court therefore agreed with Helmholz and Estate of Tully that general default rules of contract—rules that might theoretically allow modification of just about any contract in ways that would benefit the IRS—are not what’s meant in phrases like the “right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom” contained in IRC § 2036 or the “power…by the decedent alone or by the decedent in conjunction with any other person (without regard to when or from what source the decedent acquired such power)” contained in IRC § 2038.

What is meant by the rule are rights or powers created by specific instruments. A more extensive reading, as the old Court of Claims noted in Estate of Tully, would “swing a broadax to fell large swaths” of estate and retirement planning that Congress meant to allow to stand.^[67] The Tax Court therefore concluded that the IRS lost as a matter as to this point.

However, the Tax Court did think that the IRS was correct that the court also must avoid being so “blinded by any formal gleam from the Estate’s armor” that the Tax Court overlook some “practical chinks” that deals like this may have. To wit, can the IRS “dismount from purely legal or theoretical arguments” and “start wielding shorter, sharper weapons forged from the particular facts of particular cases?” the IRS obsequiously inquires.

The IRS thinks it can, and it would have the Tax Court focus on its holdings in Estate of Strangi,^[68] and Estate of Powell v. Commissioner,^[69] cases in which the Tax Court concluded that IRC § 2036(a)(2) clawed value back into a decedent’s taxable estate despite the drafting skills of talented estate lawyers. In both Estate of Strangi and Estate of Powell, the Tax Court distinguished the Supreme Court’s opinion in United States v. Byrum,^[70] in which an estate won.

In Byrum, the Supreme Court held that a decedent’s right to vote shares of stock in three corporations that he had transferred to a trust for the benefit of his children did not cause those shares to be included in his estate under IRC § 2036(a)(2). The Court noted that any powers the decedent might have had were subject to a number of different “economic and legal constraints” that prevented those powers from being equivalent to the right to designate a person to enjoy trust income.^[71]

One such constraint was that the decedent, as the controlling shareholder of each corporation whose stock was transferred into the trust, owed fiduciary duties to minority shareholders that limited his influence over the corporations’ dividend policies.^[72] The Supreme Court also noted that an independent corporate trustee alone had the right under the trust agreement to pay out or withhold income,^[73] so the decedent had no way of compelling the trustee to pay out or accumulate that income.^[74] That the decedent had fiduciary duties to these minority shareholders—duties that were legally enforceable—was important to the Supreme Court’s analysis.^[75]

The Tax Court has been careful to distinguish Byrum in later cases when the Tax Court looks behind a transaction’s facade and sees something that suggests appearance doesn’t match reality. Estate of Strangi,^[76] featured a decedent who could act with others to dissolve a family limited partnership to which he had transferred property in exchange for a 99% limited-partner interest.

The decedent in Estate of Strangi—through his son-in-law—also had the right to determine the amount and timing of partnership distributions.^[77] This led us to distinguish Byrum, because in Byrum the son-in-law had fiduciary duties to other members of the family limited partnership; in Estate of Strangi, the son-in-law’s potential fiduciary duties—as the decedent’s attorney-in-fact and 99% owner of the family limited partnership—were duties he owed “essentially to himself.”^[78]

The Tax Court decided Estate of Powell on essentially the same grounds as Estate of Strangi. In Estate of Powell,^[79] a fiduciary also owed duties to the decedent both as his attorney-in-fact and as partner in a family limited partnership. The Tax Court found that there was nothing in the record of that case to suggest that as a fiduciary he “would have exercised his responsibility as a general partner of [the family limited partnership] in ways that would have prejudiced decedent’s interests.”^[80] Further, the Tax Court again determined that whatever duties were owed were duties that “he owed almost exclusively to decedent herself.”^[81]

Here’s where the IRS made its thrust.^[82] It argued that Levine—through her attorneys-in-fact—stood on both sides of these transactions and therefore could unwind the split-dollar transactions at will. This meant that she—again through the attorneys-in-fact—had the power to surrender the policies at any time for their cash-surrender values.^[83] The IRS argued that these powers constitute the right to possession and enjoyment of, or the right to income from, the split-dollar receivable under IRC § 2036(a)(1). If the IRS is right, the Tax Court would have to value the receivable at the policies’ cash-surrender values.

The Tax Court agreed that Robert, Nancy, and Bob—as Levine’s attorneys-in-fact—stood in the shoes of Levine for this split-dollar arrangement. That is, after all, the point of giving someone a power of attorney. The Revocable Trust is the entity that paid the $6.5 million, and its cotrustees are Nancy, Larry, and Bob.

The Insurance Trust, however, owns the life-insurance policies, and its trustee is South Dakota Trust. South Dakota Trust is directed by the investment committee, and the investment committee’s only member is Bob. This, however, means that the only person that stood on both sides of the transaction is Bob—in his role as the investment committee and as one of Levine’s attorneys-in-fact.

The Tax Court therefore must look at each of Bob’s roles in this transaction to consider how to apply IRC § 2036(a) and IRC § 2038. Under the 1996 power of attorney and Minnesota law, all actions taken by Bob as an attorney-in-fact are considered to be actions of Levine.^[84] The Insurance Trust’s instrument, however, states that the Insurance Trust is irrevocable.

The Tax Court has no reason to doubt that this means what it says. The consequence, therefore, is that Levine irrevocably surrendered her interest in the Insurance Trust and had no right to change, modify, amend, or revoke its terms. Once it was created, Levine had no legal power over its assets. She did not have the power to surrender the policies by herself. Since Bob—in his role as an attorney-in-fact—could not take any action which Levine could not take herself, the Tax Court found that even Bob could not surrender the policies in his capacity as attorney-in-fact.

This means that even if the Tax Court were inclined to treat the Insurance Trust, the policies, or that Trust’s rights under the split-dollar deal as the “property transferred” (and thus the property whose value the Tax Court look for) under IRC § 2036, Levine retain no right to possession or enjoyment of the property transferred.

At this point, one would think that the IRS would have called it a day.

One would be wrong.

To obviate these “problems,” the IRS had to argue that Bob had the right to designate who shall possess or enjoy the cash-surrender value of the policies, either by surrendering them or by terminating the entire arrangement.^[85] For example, in Estate of Cahill, the Tax Court found that IRC § 2036(a)(2) applied when the decedent jointly held the right to terminate the split-dollar life-insurance policy with the irrevocable trust that held the policies.^[86] This, according to Tax Court, was the only way the IRS can include the combined cash-surrender values of the life-insurance policies in Levine’s estate under IRC § 2036(a)(2) or IRC § 2038.

This argument also fails to consider the fiduciary obligations Bob owes to the beneficiaries of the Insurance Trust—obligations that would prevent him from surrendering the policies. The IRS first questions the validity and existence of these duties. The IRS argued that “Bob was not compensated for his role as the sole member of the Investment Committee despite the fact that the petitioner has taken the position that he assumed significant fiduciary responsibilities under this role.” Because Bob wasn’t compensated, the IRS argued, his fiduciary duties were somehow less real… The Tax Court appropriately disagreed.

There is no requirement under either South Dakota law or general trust law that a trustee or trust adviser be compensated to have fiduciary obligations. The terms of the Insurance Trust expressly state that Bob—in his role as the single-member investment committee—shall be considered to be acting in a fiduciary capacity. Therefore, the Tax Court found that Bob was under fiduciary obligations in his role as the sole member of the investment committee.

Bob’s duties in his role for the Insurance Trust required him, however, to look out for the interests of that Trust’s beneficiaries. The IRS argued that, since Nancy and Robert are beneficiaries of the Insurance Trust, they stand to benefit under the split-dollar arrangement regardless of whether the life-insurance policies remain in place or are surrendered during their lifetime. This means, the IRS contended, that Bob would not violate his fiduciary duties to the beneficiaries of the Insurance Trust if he either surrendered, or didn’t surrender, the policies because Nancy and Robert would benefit no matter what.

“To this subtle thrust, the Estate has a blunt parry.”^[87] The Estate notes that Levine’s children are not the only beneficiaries under the Insurance Trust. Her grandchildren are also beneficiaries, and Bob has fiduciary obligations to them as well. According to the terms of the Insurance Trust, Levine’s grandchildren would receive nothing if the life-insurance policies were surrendered. Left unmentioned is the final step in this argument—that Bob has no right to violate his fiduciary obligations by looting the Insurance Trust for the benefit of only some of its beneficiaries.

Levine’s case is thus distinguishable from Estate of Strangi and Estate of Powell. Many of the same “economic and legal constraints” that existed in Byrum exist here. First, the fiduciary obligations that Bob owed were not duties that he “essentially owed to himself.” His fiduciary obligations are owed to all the beneficiaries of the Insurance Trust, which include not just Levine’s children, but her grandchildren. Thus, if Bob surrendered the life-insurance policies, those grandchildren would receive nothing as beneficiaries.

Such fiduciary obligations are, therefore, more analogous to the duties owed to the minority shareholders in Byrum, which like them are duties that do limit the powers of the person who holds them. They are also legally enforceable duties, established by South Dakota state law,^[88] and if Bob breached these duties or was put in a position where he was forced to do so, he would be required under South Dakota law to inform all beneficiaries of the Insurance Trust, and he could be removed.^[89] He could also be subject to liability under South Dakota law for breach of his duty.^[90]

The Tax Court stress that the fiduciary duties that Bob owed to the beneficiaries of the Insurance Trust do not conflict with the fiduciary duties that he owed Levine as one of her attorneys-in-fact. In both Estate of Strangi and Estate of Powell, the Tax Court held that the fiduciary’s role as the attorney-in-fact would potentially require him to go against his duties as a trustee.^[91] This is not the case here.

Under Minnesota law (where the decedent lived and the trusts were formed (with the exception of the Insurance Trust), whenever Bob and the other attorneys-in-fact exercise their powers, they are to do so “in the same manner as an ordinarily prudent person of discretion and intelligence would exercise in the management of the person’s own affairs and shall have the interests of the principal utmost in mind.”^[92] Bob, Nancy, and Robert all credibly testified that one of the reasons for this split-dollar arrangement was that Levine wished to provide for her grandchildren and keep this arrangement in effect until the insureds died.

Thus, not only did Bob’s role as an attorney-in-fact not require him to go against his duties as a trustee, the two roles reinforced each other and pushed him to fulfill Levine’s stated purpose in her estate planning. They made it more likely that he would not want to cancel the life-insurance policies.

The Tax Court therefore found it more likely than not that the fiduciary duties that limit Bob’s ability to cancel the life-insurance policies were not “illusory.” The Tax Court was also persuaded that it cannot characterize Bob’s ability to unload the policies and realize their cash-surrender values as a right retained by Levine, either alone or in conjunction with Bob, to designate who shall possess or enjoy the property transferred or the income from it. Therefore, the Tax Court concluded the inclusion of the cash-surrender values of the life-insurance policies in Levine’s estate under IRC § 2036(a)(2) was precluded.

Analysis: IRC § 2038

IRC § 2038 focuses on a decedent’s power to “alter, amend, revoke, or terminate” the enjoyment of the property in question. The IRS’s argument under IRC § 2038 mirrored its argument under IRC § 2036. To wit—the attorneys-in-fact have controlled the entirety of Levine’s affairs since 1996, and that this control includes the ability to “alter, amend, revoke or terminate” any aspect of the split-dollar arrangements.

It recycled its argument that the termination of the split-dollar arrangements would provide Levine—through her attorneys-in-fact—with complete control over the cash-surrender values of the policies, and the power to do this would fall within IRC § 2038(a)(1). It argued that IRC § 2038(a)(1) applies for the same reasons that IRC § 2036 applied. Accordingly, the Tax Court summarily disagreed for the very same reasons regarding IRC § 2038 as it had for IRC § 2036. Thus, the cash-surrender values of the insurance policies were not includible under IRC § 2038(a)(1).

Analysis: IRC § 2703

As a third alternative, the IRS argued that the special valuation rules under IRC § 2703 apply to Levine’s split-dollar arrangement. IRC § 2703(a) provides generally that the value of any property is determined without regard to (i) any option, agreement, or other right to acquire or use the property at a price less than the fair market value of the property (without regard to such option, agreement, or right), or (ii) any restriction on the right to sell or use such property.

The IRS argued that when Levine—through her attorneys-in-fact—entered into the split-dollar arrangement, she placed a restriction on her right to control the $6.5 million in cash and the life-insurance policies. Such restriction on Levine’s right to unilaterally access the funds (somehow) transferred to the insurance companies for the benefit of the Insurance Trust is what should be disregarded when determining the value of the property under IRC § 2703(a)(2).

The Estate argued, in contrast, that IRC § 2703 applies only to property owned by Levine at the time of her death, not to property she’d disposed of before, or property like the insurance policies that she never owned at all. If the inability to surrender the life-insurance policies is considered a “restriction,” it is not a restriction on any property rights held by Levine since she never owned the policies.

The IRS doesn’t parry this other argument,^[93] but argues instead that if the Tax Court focus on the “rights” held by Levine under the split-dollar arrangement—and not the $6.5 million in cash—the result would remain the same. In essence, the IRS “wants [the Tax Court] to imagine that despite the different language in the split-dollar arrangement here compared to those in Morrissette II and Estate of Cahill, [the split-dollar arrangement in Estate of Levine v. Commissioner] should still be read to mean that both parties may consent to any early termination of the insurance policies.” Without this restriction, the IRS argued, the value of Levine’s rights would equal the cash-surrender values of the life-insurance policies.

The Tax Court politely disagreed.

IRC § 2703 does refer to “any property.” However, the “any property” it refers to is property of an estate, not some other entity’s property. The Tax Court’s caselaw confirms the plain meaning of the Code, and it instructs the Tax Court to confine the valuation rule of IRC § 2703 to property held by a decedent at the time of her death.^[94] The district court in Church v. United States,^[95] rejected precisely this argument when it held that “property” in IRC § 2703 consideration does not include assets that a decedent contributed to a partnership before her death, but only the partnership interest she got in exchange.^[96]

The property the Tax Court had to value Estate of Levine v. Commissioner was the property in Levine’s estate, which is the split-dollar receivable she held at the time of her death. There were no restrictions on that property. She could do with the receivable what she wanted. She was free to sell it or transfer it as she wished.

The Tax Court admonishes that “[o]ne needs to remember that what the Estate valued on its return was the receivable owned by Levine in her Revocable Trust,” and “IRC § 2703 is not relevant to the valuation of the receivable because Levine had unrestricted control of it.” IRC § 2703 therefore did not apply to the present split-dollar arrangement.

The only property left in the Estate after this arrangement was done was the split-dollar receivable. It is the value of that property that must be included in the gross estate, and the parties have agreed that its value is $2,282,195.

The Coup de Grâce Regarding Penalties

Judge Holmes, in passing, deals the felled IRS a final death blow.^[97]

The Estate having almost entirely prevailed, no accuracy-related penalties apply.

And the jousting match comes to a painful, albeit fitting, end for the IRS, as it looks up from its collective administrative rear to see its steed charging away, a painful welt swelling under its government-issued breastplate where it was knocked asunder by the unforgiving lance of the Code.

(158 T.C. No. 2) Estate of Levine v. Commissioner

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Footnotes:

1. 146 T.C. 171 (2016). ↑
2. T.C. Memo. 2018-84. ↑
3. “Uncle Sam,” of course, is the anthropomorphized personification of the Federal government, which has come to resemble a wizened older gentleman in a white top hat, engirded with a blue ribbon, itself emblazoned with large white stars, pointing towards “you” in a 1917 recruitment poster for the U.S. Army created by created by James Montgomery Flagg, which image was repurposed and made all the more famous in World War II. Interestingly (for me at least), the first reference to Uncle Sam in literature was in the 1816 allegorical book The Adventures of Uncle Sam, in Search After His Lost Honor by Frederick Augustus Fidfaddy, Esq. The tome, Fidfaddy’s sole work, was a satire on the policies of the United States leading up to the War of 1812. Fidfaddy appears to be a nom-de-plume, as Mr. Fidfaddy, himself, concedes when he answers the rhetorical question, “who is Tid Fid Faddy?” The good author pivots and replies, “Aye, but honest friend, what is there, in these degenerate days that does always pass by its real, deserved name?” The Adventures of Uncle Sam, 6 (repub. 1971, Liberty House). ↑
4. See Minn. Stat. IRC § 523.23 (2005). ↑
5. Estate of Hurford v. Commissioner, T.C. Memo. 2008-278 (citing Bittker et al., Federal Estate and Gift Taxation 80-81 (9th ed. 2005)). ↑
6. See Grieve v. Commissioner, T.C. Memo. 2020-28, *6 & n.4. ↑
7. Id. ↑
8. Treas. Reg. § 20.2036-1(c)(2)(i). ↑
9. See Treas. Reg. § 25.2701-1 through Treas. Reg. § 25.2701-8. ↑
10. See IRC § 2702; Treas. Reg. § 25.2702-5. ↑
11. See Estate of Riese v. Commissioner, T.C. Memo. 2011-60. ↑
12. The halberd—a two-handed pole weapon that came to prominent use during the 14th, 15th, and 16th centuries—consists of an axe blade topped with a spike mounted on a long shaft. It always has a hook or thorn on the back side of the axe blade for grappling mounted combatants. See Halberd, Wikipedia.org. ↑
13. See Likly & Rockett Trunk Co. v. Provident Mut. Life Ins. Co., 85 F.2d 612, 613 (6th Cir. 1936). ↑
14. See Estate of Petter v. Commissioner, T.C. Memo. 2009-280, aff’d, 653 F.3d 1012 (9th Cir. 2011). ↑
15. See S.D. Codified Laws ch. 55-1B (1997). ↑
16. See S.D. Codified Laws § 55-1B-4 (1997). ↑
17. See Estate of Bullard v. Commissioner, 87 T.C. 261, 265 (1986). ↑
18. Id. at 270-71. ↑
19. See Treas. Reg. § 1.61-22(d)(2). ↑
20. See Treas. Reg. § 25.2512-1. ↑
21. See De Los Santos v. Commissioner, T.C. Memo. 2018-155. ↑
22. Id. ↑
23. Treas. Reg. § 1.61-22(b)(1). ↑
24. Treas. Reg. § 1.61-22(b)(3)(i). ↑
25. Treas. Reg. § 1.61-22(c)(1). ↑
26. Treas. Reg. § 1.61-22(c)(2). ↑
27. Treas. Reg. § 1.61-22(c)(1)(ii)(A)(2). ↑
28. 146 T.C. 171. ↑
29. 146 T.C. at 172 n.2 ↑
30. T.D. 9092, § 5. ↑
31. See IRC § 2042(1); Treas. Reg. § 20.2042-1(a)(2) (stating that “IRC § 2042 has no application to the inclusion in the gross estate of the value of rights in an insurance policy on the life of a person other than the decedent”). ↑
32. IRC § 2501(a). ↑
33. IRC § 2036(a); IRC § 2038(a)(1). ↑
34. See IRC § 2703(a). ↑
35. Strangi v. Commissioner, 417 F.3d 468, 476 (5th Cir. 2005), aff’g Estate of Strangi v. Commissioner, T.C. Memo. 2003-145; Estate of Bigelow v. Commissioner, 503 F.3d 955, 963 (9th Cir. 2007), aff’g T.C. Memo 2005-065; Estate of Thompson v. Commissioner, 382 F.3d 367, 375 (3d Cir. 2004). ↑
36. Estate of Bongard v. Commissioner, 124 T.C. 95, 113 (2005); Estate of Jorgensen v. Commissioner, T.C. Memo. 2009-66, aff’d, 431 F. App’x 544 (9th Cir. 2011). ↑
37. Estate of Jorgensen, T.C. Memo. 2009-66, *7 (citing Estate of Bongard, 124 T.C. at 113). ↑
38. Estate of Morrissette v. Commissioner (Morrissette II), T.C. Memo. 2021-60, *66, (quoting Guynn v. United States, 437 F.2d 1148, 1150 (4th Cir. 1971)). ↑
39. The fifth jousting metaphor. Yes, we’re counting. ↑
40. Treas. Reg. § 20.2036-1(c)(1)(i). ↑
41. Treas. Reg. § 20.2036-1(b)(2). ↑
42. That would be number 6 for the jousting metaphors… ↑
43. Lucky number 7… ↑
44. See Joseph M. Perillo, Contracts (7th ed. 2014). ↑
45. IRC § 2036(a)(2). ↑
46. No. 8… ↑
47. 296 U.S. 93 (1935). ↑
48. Id. at 96. ↑
49. Id. at 94. ↑
50. Id. ↑
51. Id. at 96. ↑
52. Id. at 97. ↑
53. Id. at 96. The Tax Court notes that here the quote is from the slightly different language of the Code’s equivalent of IRC § 2038 “back then,” with “back then” meaning 1927, with the applicable quote coming from § 1094 of the Revenue Act of 1926. ↑
54. Id. at 97. ↑
55. Id. at 96. ↑
56. Id. at 97. ↑
57. Id. ↑
58. 528 F.2d 1401 (Ct. Cl. 1976). ↑
59. Id. at 1402. ↑
60. Id. ↑
61. Id. ↑
62. Id. at 1403. ↑
63. Id. ↑
64. Id. at 1404. ↑
65. Id. at 1405. ↑
66. Pine Mountain Pres. LLLP v. Commissioner, 151 T.C. 247, 282 (2018), rev’d in part, aff’d in part, vacated and remanded, 978 F.3d 1200 (11th Cir. 2020). ↑
67. Give the IRS a broadax, and we’re all in deep trouble. ↑
68. T.C. Memo. 2003-145. ↑
69. 148 T.C. 392 (2017). ↑
70. 408 U.S. 125 (1972). ↑
71. Id. at 144. ↑
72. Id. at 142-43. ↑
73. Id. at 137. ↑
74. Id. at 144. ↑
75. Id. at 141-42. ↑
76. T.C. Memo. 2003-145. ↑
77. Id. ↑
78. Id. ↑
79. 148 T.C. at 394-95. ↑
80. Id. at 404. ↑
81. Id. ↑
82. And number ten… ↑
83. Remember that, under the terms of the split-dollar arrangements, if the Insurance Trust surrendered the policies before the deaths of both Nancy and her husband, it would immediately owe the Revocable Trust the full cash-surrender values of the policies. ↑
84. See Minn. Stat. IRC § 523.12 (2008). ↑
85. See Estate of Cahill, T.C. Memo. 2018-84, slip op. at *14-*21. ↑
86. Id. ↑
87. Eleven. ↑
88. See, e.g., S.D. Codified Laws § 55-2-1, 55-1B-4 (2008) ↑
89. S.D. Codified Law § 55-2-6 (2008). ↑
90. See, e.g., Matter of Heupel Fam. Revocable Tr., 914 N.W.2d 571 (S.D. 2018) (trustee breaching fiduciary duties removed and required to personally reimburse trust). ↑
91. Estate of Strangi, T.C. Memo. 2003-145.; Estate of Powell, 148 T.C. at 404. ↑
92. Minn. Stat. IRC § 523.21 (1992). ↑
93. And we’ve reached an even dozen. ↑
94. See, e.g., Estate of Strangi v. Commissioner, 115 T.C. 478 (2000), aff’d in part, rev’d in part, 293 F.3d 279 (5th Cir. 2002). ↑
95. 2000 WL 206374 (W.D. Tex. 2000), aff’d without published opinion, 268 F.3d 1063 (5th Cir. 2001). ↑
96. See also Estate of Strangi, 115 T.C. at 488 (observing that “Congress ‘wanted to value property interests more accurately when they transferred, instead of including previously transferred property in the transferor’s gross estate’”) (citing Kerr v. Commissioner, 113 T.C. 449 (1999), aff’d, 292 F.3d 490 (5th Cir. 2002)). ↑
97. Literally translated, coup de grâce means “a stroke of grace,” and means a single, final blow or stroke, dispatching one condemned or mortally wounded to put an end to misery. “Coup” is derived through Old French from Medieval Latin colpus, from Vulgar Latin colapus, from Latin colaphus “a cuff, box on the ear,” from Greek kolaphos “a blow, buffet, punch, slap.” This is where the etymological trail loses is scent, with one scholar noting that kolaphos is “a lowly word without clear etymology.” Etymonline.com. ↑

 

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