Related Attorney(s): Micah A. Bonaviri, Caroline Ford Bonaviri, David S. De Jong, Ann G. Jakabcin, David B. Torchinsky , Steven A. Widdes,

On December 17, 2010, President Obama signed a new tax law that modified the estate tax for 2011 and 2012. Specifically, a decedent dying during 2012 will have an exemption from estate tax of $5.12 million. Any assets with a value in excess of this amount will be subject to a 35% estate tax. These federal laws are only temporary and we are unsure what the laws will be for 2013.

Although the federal estate tax exemption is currently $5.12 million, the Maryland and D.C. estate tax exemptions are $1 million today while no estate tax is imposed in Virginia. The federal and especially the state exemption amount can be used up quickly by life insurance death benefits that, while typically income-tax-free, are includable in your estate if you own the policy or have rights to it.

A properly drafted Irrevocable Life Insurance Trust (“ILIT”) provides a number of useful estate planning benefits. Perhaps the most common reason to use an ILIT is to remove the life insurance proceeds from both the grantor’s and the spouse’s taxable estate while allowing the proceeds to be available to meet the needs of the surviving spouse and descendants. However, it is important to ensure that the grantor does not retain any “incidents of ownership” over the policies that would cause the insurance proceeds to be included in the grantor’s estate. Accordingly, the ILIT is intended to be the owner and the beneficiary of the life insurance policy.

There are additional reasons why an ILIT may be useful:

1. The life insurance proceeds held in an ILIT can provide liquidity to pay estate taxes, as well as other debts and expenses, by purchasing assets from the grantor’s estate or through a loan.
2. The ILIT serves as a vehicle to manage and control life insurance proceeds. Assets held in an ILIT are generally protected from the creditors of a beneficiary because the ILIT can be designed to give the Trustee the discretionary power to make distributions. This is especially useful if the grantor has children who are minors or who otherwise need financial protection.
3. The ILIT leverages the grantor’s generation skipping transfer (GST) tax exemption because the grantor’s GST tax exemption can be allocated to an ILIT holding a life insurance policy that may substantially increase in value. As a result, numerous generations may benefit from the trust assets free of federal estate and GST tax.
4. A properly drafted ILIT avoids adverse gift tax consequences. Contributions, such as premium payments made to the Trust, are deemed to be gifts to the beneficiaries. In order to avoid adverse gift tax consequences, the trust must follow certain procedural requirements named after the famous “Crummey” tax case. To avoid adverse gift tax consequences, it is crucial that the Trustee, using a “Crummey” letter, notify the beneficiaries of the Trust of their right to withdraw a share of contributions for a 30 day period. This procedure qualifies the transfer for the annual gift tax exclusion (currently $13,000), avoiding the need in most cases to file a gift tax return with the resulting reduction of the federal exemption at death.

A properly drafted ILIT can accomplish many estate planning objectives. However, because of strict IRS guidelines, it is crucial that certain drafting and procedural requirements be followed to ensure that the beneficiaries realize the full benefits offered by the ILIT.

If you have any questions about this or other estate planning issues, please call 301-340-2020.

Estates + Trusts Law at Stein Sperling

Stein Sperling’s Estates and Trusts practice provides a broad range of services that include the organization and development of estate plans, assistance in the administration of trusts and estates, and working with clients step-by-step through the probate process. Our attorneys combine experience, knowledge and the practical applications of estate, trust, business and tax laws with innovative approaches designed to meet clients’ needs and objectives.