Miles, James M.

English

University of North Carolina School of Law

NORTH CAROLINA LAW REVIEWVolume 46 | Number 4 Article 226-1-1968Taxation -- Reintroduction of the PremiumPayment Plan?James M. MilesFollow this and additional works at: http://scholarship.law.unc.edu/nclrPart of the Law CommonsThis Note is brought to you for free and open access by Carolina Law Scholarship Repository. It has been accepted for inclusion in North Carolina LawReview by an authorized editor of Carolina Law Scholarship Repository. For more information, please contact law_repository@unc.edu.Recommended CitationJames M. Miles, Taxation -- Reintroduction of the Premium Payment Plan?, 46 N.C. L. Rev. 989 (1968).Available at: http://scholarship.law.unc.edu/nclr/vol46/iss4/22ESTATE TAXATIONthat such power is inherent even in the absence of statute 9 supportthe desirability and propriety of denominating all new affirmativematter in the reply as an amendment to the complaint.The proposed new rules limit the scope of the problem consider-ably since a reply is only allowed in response to a counterclaimdenominated as such, or when ordered by the court.2" Thus, unlessthe courts hold contrary to the apparent intention of the new rules,the number of instances when plaintiff may run afoul of NorthCarolina restrictions on the reply will be sharply reduced. Noting,however, that under the new rules, the complaint may contain claimswhich are alternative, inconsistent, or unrelated,2 the striking ofthe reply as not being defensive seems to find even less justification.WILLIAM S. GEIMERTaxation-Reintroduction of the Premium Payment Plan?In Revenue Ruling 67-4631 the Commissioner of Internal Rev-enue has taken the position that when a husband transfers all inci-dents of ownership of an insurance policy to his wife more thanthree years prior to his death, but continues to pay the premiumsuntil his death, the premiums paid within the -last, three years arepaid in contemplation of death and represent a transfer of an in-terest in the policy. The interest transferred is measured by theproportion the amount of premiums so paid bears to the total amountof premiums paid; therefore, the proportionate value of the in-surance bought by these premiums is includible in his gross estateunder section 2035.2 Arguably, this ruling is a reintroduction of the.old "premium payment" plan rejected by Congress in 1954.In making this ruling, the Commissioner could have taken two"' Gilliam Furniture Inc. v. Bentwood Inc., 267 N.C. 119, 120, 147 S.E.2d612, 613 (1966)." PROPOSED N.C. RuLEs CIv. PROc. 7(a) (1967)."'PROPOSED N.C. RULES CIV. PROC. 8(e) (1967).'Rev. Rul. 67-463, 1967 IN'T. REv. BULL. No. 52, at 15.2 INT. REV. CODE of 1954, § 2035. For example, if A buys an insurancepolicy worth one hundred thousand dollars and pays eight thousand dollarsin premiums over a four year period, with six thousand dollars being paidover the last three years prior to death, the Commissioner would include inhis gross estate three-fourths of the value of the policy or seventy-fivethousand dollars, and not the six thousand paid for the premiums,19681NORTH CAROLINA LAW REVIEWother positions . He might have included the entire proceeds ofthe policy in decedent's estate on the theory that the payment ofthe last premium kept alive the right to receive the proceeds upondeath. Or he could have included in the taxable estate only theamount of the premium payments actually made by the decedentwithin the three year period. However, the Commissioner chose thethird alternative, ruling that "unlike the unrestricted gift of money,a premium payment is a gift of insurance protection, a transfer ofan interest in the policy."' 4 The Revenue Ruling's position is contraryto that in Lamade v. Brownell.5 The two fact situations seem indis-tinguishable. The court in Lamade holds that where the insured hasabsolutely assigned the policy to his wife, having never exercisedany incidents of ownership in the policy, the proceeds are not in-cludible in his gross estate even though the insured had paid premiumson it for the two years immediately prior to his death. The courtsaid that "the payment of premiums on said policy by the decedentfor the two years immediately prior to his death was by way ofgift.",6The Internal Revenue Code of 1954 changed the then existinglaw and provided in Section 2042' that the sole test for determiningwhether proceeds, not payable to the executor, are includable in thedecedent's estate is whether the decedent retained any of the inci-dents of ownership in the policy at his death." The congressionalintent was to place life insurance on a par with other property,which may be given away free from estate tax if not made in con-templation of death or in violation of the other inter vivos trans-fer sections. It was felt by the majority of members of the HouseWays and Means Committee that to discriminate against lifeinsurance was unjustified, in that it should be the nature of the dis-* Moses, Irrevocable Life Insurance Trusts Can Be Attractive EstatePlanning Toot, 18 J. TAXATION 206, 211 (1963).'Rev. Rul. 67-463, 1967 INT. REV. BULL. No. 52, at 15.'245 F. Supp. 691 (M.D. Pa. 1965). Cited with approval in UnitedStates v. Rhode Island Trust Co., 355 F.2d 7, 12 n.4 (1st Cir. 1966).6245 F. Supp. at 697.'INT. REv. CODE of 1954, § 2042.8 H.R. REP. No. 1337, 83d Cong., 2nd Sess. 90 (1954). The House Waysand Means Committee said: "The bill (sec 2042) would make a basic changeby excluding life insurance proceeds from the taxable estate of the insuredunless at his death he possesses 'incidents of ownership' of the policy. Wherethe insured gives away the beneficial interest in the policy, but pays thepremiums, the death benefits would no longer be taxed in his estate." Id. atB 14.[Vol. 461STATE TAXATIONposition rather than the property which determines the testamentarycharacter of the gift.9Section 2042 of the Internal Revenue Code, is not, of course,the only section under which the proceeds of life insurance can beincluded in the gross estate. Section 203510 treats a transfer ofthe incidents of ownership within three years of death as beingin contemplation of death. However, the Revenue Ruling applieswhere all the incidents of ownership of the policy itself are trans-ferred more than three years before death. The only question bfthis Revenue Ruling is whether the money used to pay the prem-iums, admittedly transferred in contemplation of death, representsmore than the actual dollar amount of the premium.The Commissioner cites several cases in support of his affirma-tive position. Chase National Bank v. United States" is cited forthe proposition that a "transfer" means more than the passing ofitems of property directly from the decedent to the transferee, andincludes the transfer of property procured through expendituresby the decedent which results in having it pass to another. Thecourt in this refund case was concerned with plaintiff's argumentthat because the proceeds were payable from the insurance companyto the beneficiary, rather than directly from the insured, there wasnothing on which a transfer tax from the insured to the beneficiarycould be imposed. The crux of the argument centers on the worddirectly. The court said that "the power to tax the privilege of trans-fer at death cannot be controlled by the mere choice ... of the par-ticular methods by which his purpose is effected, so long as he re-tains control over those benefits."'" This case is distinguishablefrom the Revenue Ruling, because it involves a complete transferof the policy in which the decedent has no control over the benefitsalready transferred. The only property under his control is themoney used to pay the premiums.' Id. The minority position is also stated in the Reports "But life insuranceis not like other property. It is inherently testamentary in nature. It is de-signed, in effect, to serve as a will, regardless of its investment features.Where the insured has paid the premiums on life insurance for the purposeof adding to what he leaves behind at his death for his beneficiaries, the in-surance proceeds should certainly be included in his taxable estate." Id.10 INT. REv. CODE of 1954, § 2035.11278 U.S. 327 (1929). Lehman v. Commissioner, 109 F.2d 99 (2d Cir.1940), cert. denied, 310 U.S. 637 (1940), is cited for the same proposition.22 278 U.S. at 338.1968]NORTH CAROLINA LAW REVIEWLiebman v. Hassett,3 according to many writers, 14 constitutesvalid authority for the Commissioner's position in the RevenueRuling. The case involved an assignment of a policy by the de-cedent to his wife two years before his death, thus raising a pre-sumption of a transfer "in contemplation of death." Since the as-signee had paid the two premiums during the period between as-signment and death, it was held that the face value of the policyless the pro rata amount of insurance purchased with the two prem-iums paid by the assignee was to be included in the gross estate.In anticipation of the position taken by the Commissioner in thisRevenue Ruling two writers 5 have already explored the differenti-ating factors between the Liebman situation and the rationale of thepresent ruling. The most distinguishable factor is that in Liebmanthe policy itself was transferred in contemplation of death. In theRevenue Ruling the policy and all incidents of ownership weretransferred more than three years before death with only a prem-ium payment being transferred in contemplation of death. More-over, it is necessary to consider the word "transfer" as used inSection 2035, which includes in the gross estate "property [exceptreal property situated outside of the United States] to the extent ofany interest therein of which the decedent has at any time made atransfer . . . in contemplation of his death."' 6 The emphasis is ona transfer of property made during decedent's life, and what is in-cluded is the value of the property which was the subject of theinter vivos transfer. "Although the tax is to be measured by thevalue of the transferred property as of the date of the donor'sdeath, this does not mean that, for the purpose of determining what148 F.2d 247 (1st Cir. 1945)."See W. WARREN & S. SURY, FEDERAL ESTATE AND GiFT TAXATION523 (1961 ed.) ; Mannheimer, Wheeler, Friedman, Gifts of Life InsuranceBy the Insured, N.Y.U. 13TH INST. ON FED. TAX. 260 (1954); Moses, Ir-revocable Life Insurance Truists Can Be Attractive Estate Planning Tool,18 J. TAXATION 206, 211 (1963); J. Am. Soc'y C.L.U., Spring 1962, 117,131." Brown & Sherman, Payment of Premiums as Tratsfers in Contempla-tion of Death, 101 TRUSTS & ESTATES 790 (1962). The authors also pointout that even if there had been no assignment the same portion of the pro-ceeds would have been excluded. The case was decided under the RevenueAct of 1926, Sec. 302(g). This section made life insurance, payable tonamed beneficiaries, taxable to the extent that it was "taken out" by the de-cedent. Under T.D. 5032, 36 TREAS. DEC. INT. REv. 15 (1941), "taken out"meant the extent decedent paid the premiums.6 INT. REv. CODE of 1954, § 2035.[Vol. 46ESTATE TAXATIONproperty was transferred, the gifts should be regarded as havingbeen made as of the date of death."'17 It is arguable therefore thatif the decedent owns no part of the policy (having transferred allincidents of ownership to the assignee more than three years beforedeath) the value of the gift should be determined by what propertyis still under his control, i.e. the money used to pay the premiums.Reinforcing this argument is the expressed wish of Congress toeliminate the payment of premium plan in section 2042 of the 1954Code,' s and the fact that Liebman is a 1943 decision. WhetherLiebman should be considered good authority in a contemplation ofdeath case, even if it were on "all fours," is questionable in view ofthe 1954 changes in section 2042. It seems reasonable to assumethat Congress intended to eliminate the payment of premium testaltogether, considering the expressed purpose of the Committee totreat insurance like any other property. If decedent transfers in-come producing property, the taxability of the income depends onwhether the transferor completely divested himself of all interests inthe property, and if he did, the income is not taxable to him. 9Similarly, the increased value of the policy should not be taxed to himbecause he has completely transferred all incidents of ownership.The recent case of Scott v. Commissioner"° is cited by the Com-missioner as holding that upon the husband's death, the propor-tionate part of the proceeds of the policy attributable to his paymentof the premiums is includible in his gross estate. The facts showthat decedent and his wife owned the policies as community propertyunder California law. The wife predeceased her husband and be-queathed to her sons her one-half community interest in policieson his life. After her death, the husband paid premiums on thepolicies, and the court held that the proportionate part representedby his payment of premiums was includible in his estate. 21McGhee v. Commissioner, 260 F.2d 818, 820 (5th Cir. 1958).H.R. REP. No. 1337, 83d CONG. 2d SEss. 90 (1954).See Treas. Reg. § 20.2035-1(e) (1964); Jacob Gidwitz, 14 T.C. 1263(1950) af'd, 196 F.2d 813 (7th Cir. 1952); James E. Frizzel, 9 T.C. 979(1947), aff'd on reconsideration, 11 T.C. 576 (1948), aff'd 177 F.2d 739(5th Cir. 1949).20374 F.2d 154 (9th Cir. 1967).21 The regulations since 1949 have stated that in determining whether ornot a decedent possessed any incidents of ownership in a policy, regard mustbe given to the effect of the state or applicable law upon the terms of thepolicy. Thus, California property law must be consulted to determinewhether incidents of ownership are possessed in an insurance policy pur-chased with community funds. See R. PAUL, SELECTED STUDIES IN FEDERAL1968]NORTHI CAROLINA LAW REVIEWCalifornia cases clearly hold that such insurance contracts may beseparate property, community property, or mixed, depending uponthe source of the premium payments. 22 Thus, to the extent of de-termining whether a policy is community property the premiumpayment test is preserved. This is quite different from the RevenueRuling in that the question is not the determination of a communityproperty interest, but whether the transfer involved more thanthe actual money given in contemplation of death.The issue facing the Commissioner involved the basic determina-tion of exactly what property interest the payment of a premiumrepresented. As stated by the Supreme Court, the estate tax "ex-tends to the creation, exercise, acquisition, or relinquishment of anypower or legal privilege which is incident to the ownership of prop-erty."23 Basic to a transfer is the transmission from one to anotherof an interest in property. The interest must be capable of existingand must be one which is in fact transferred.2 4 If the interest ex-ists, then a determination of some value on the interest should bepossible. To find the fair market value of a property interest at thedecedent's death the test is to put oneself in the position of a po-tential purchaser of the interest at that time.2" It is submitted that apurchaser would give little for the "interest" decedent had in thepolicy for the three years prior to death. He had transferred allincidents of ownership and therefore had no control over the prop-erty which was in the hands of the recipient.2"It is hoped that the reasoning of the Lamade case, combinedwith the expressed intent of Congress, will be followed when RevenueRuling 67-463 is litigated. To find for the Commissioner would bea reintroduction of the payment of premium test, at least in spirit.This test was abandoned by Congress in 1954 and should not bereestablished by judicial interpretation of section 2035. If the resultadvocated by the Revenue Ruling is desirable, then section 2035or section 2042 should be amended by Congress to reflect such adesire. JAMES M. MILESTAXATION 1-33 (2d ser. 1938). See also Lang v. Commissioner, 304 U.S. 264(1938).2 2 Travelers Ins. Co. v. Fancher, 219 Cal. 351, 26 P.2d 482 (1933); Gett-man v. Los Angeles, 87 Cal. App. 2d 862, 197 P.2d 817 (Dist. Ct. 1948).23Fernandez v. Wiener, 326 U.S. 340, 352 (1945)."' Eleanor A. Bradford, 34 T.C. 1059, 1064 (1960)." United States v. Land, 303 F.2d 170 (5th Cir. 1962).2 But see Walter v. United States, 341 F.2d 182 (6th Cir. 1965).[Vol. 46

Taxation -- Reintroduction of the Premium Payment Plan?

bepress Legal Repository

https://scholarship.law.unc.edu/cgi/viewcontent.cgi?article=6258&amp;context=nclr

Taxation -- Reintroduction of the Premium Payment Plan?

Abstract

Similar works

Full text

Available Versions

University of North Carolina School of Law

bepress Legal Repository