The Irrevocable Life Insurance Trust (“ILIT”) is a well-known planning tool. Typically, this type of trust shelters a life insurance death benefit from the insured's estate taxes and can be used to pay such taxes and settlement costs. ILIT planning is especially beneficial when an estate consists largely of illiquid assets – after all, who wants to sell off the family farm to pay Uncle Sam’s bill?
In order to escape taxation upon the insured’s death, the trust must be irrevocable. Clients have concerns about irrevocable trusts, however, because they cannot be revoked or cancelled by the grantor once established. The terms of the trust also cannot be changed. However, an irrevocable trust need not be a dead end.
While difficult, it may be possible to modify the terms of an irrevocable trust if the grantor and the beneficiaries all consent. In certain jurisdictions, decanting (appointing the assets of one trust into another trust) may also be an option. In fact, this year, Virginia enacted legislation validating a trustee’s decanting power, although such power is subject to limitations. (Note that Virginia is now one of more than a dozen states to enact decanting statutes.)
A recent Private Letter Ruling (“PLR”) issued by the IRS shed light on another possible strategy for ILITs. However, because a PLR is issued to a specific taxpayer and has no precedential value, it must be read with caution. At issue in the PLR was an ILIT which owned a taxpayer’s life insurance policy. Ultimately, without modifying or decanting from the original ILIT, the taxpayer indirectly will be able to move the policy into a second trust containing a different distribution scheme.
In this case, the ILIT will sell the policy (for its gift tax value) to a second irrevocable trust established by the taxpayer for the benefit of taxpayer’s descendents. Because the IRS considered the second trust to be a grantor trust, with the grantor being both the taxpayer and the insured, the transfer of the policy to the second trust will not subject the death benefit to income tax liability. Furthermore, the IRS ruled that the policy proceeds will not be includible in the taxpayer’s gross estate upon the taxpayer’s death. These results illustrate the possibility of altering an estate plan, even when an irrevocable trust is in play.
ILITs are a highly beneficial planning tool. To discuss any type of irrevocable trust and/or how an existing irrevocable trust can be modified, changed or decanted, call us at (301) 468-3220 or e-mail us at liz@altmanbackup.peakperformance.dev.