Generally, while the IRS has the ability to argue "substance over form," in determining the tax consequences of a situation taxpayers are generally bound by the legal form of the transaction or situation. In regard to issues involving life insurance policies, this means that taxpayers are generally bound by the "policy facts" - the objective facts of who has ownership and other rights over the policy. This further means that contrary "intent facts" will be disregarded - even if the taxpayer intended something different from what actually occurred.
In the world of insurance and insurance trusts, who owns an insurance policy, whether or when a policy is transferred, and beneficiary designations can have substantial tax consequences, especially in regard to estate and gift taxes. What happens if the parties intended one thing, but they did the paper work wrong and what they intended is not legally what occurred? Under the "policy facts" principle, they are generally stuck with the legal effect of what actually occurred.
In the world of insurance and insurance trusts, who owns an insurance policy, whether or when a policy is transferred, and beneficiary designations can have substantial tax consequences, especially in regard to estate and gift taxes. What happens if the parties intended one thing, but they did the paper work wrong and what they intended is not legally what occurred? Under the "policy facts" principle, they are generally stuck with the legal effect of what actually occurred.
In a recent Private Letter Ruling, the IRS provided an exception to this. In the ruling, the taxpayers had given instructions to their insurance agent to exchange a life insurance policy and then transfer the new policy into an insurance trust. Years later, they discover that the transfer to the trust was never made. The taxpayers requested a ruling that if they transfer the policy to the trust now, there will not be a current gift, and the three year rule of Code Section 2035 (which provides that a life insurance policy transferred by an owner/insured to an irrevocable trust will be taxable in the estate of the owner/insured if he or she dies within 3 years of the transfer) will not apply.
In finding an exception to the application of "policy facts," the IRS ruled favorably that there would be no current transfer and Code Section 2035 would not apply. The IRS extrapolated from existing case law and provided that where the insurance contract does not reflect the instructions of the parties, the IRS will respect the intent of the parties and characterize the tax consequences based on that intent as manifested by their instructions.
PLR 200603002
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