Private Letter Ruling
Number: 9152031
Internal Revenue Service
September 30, 1991

Symbol: CC:P&SI:Br.4-TR- 31-539- 91

Uniform Issue List No.: 1361.00-00

This is in response to your letter dated March 12, 1991, and other submissions in which you request a ruling that a reorganization of certain general partnerships, investment, and holding companies into a group of limited partnerships and “subchapter S” corporations (S corporations) will not subject the buy-sell agreement incorporated in both groups of entities to section 2703 of the Internal Revenue Code.

You represent that the A general partnership was formed under New York law in 1969. Its assets consist of interests in parcels of real property and a portfolio of marketable securities. In most cases the A general partnership owns a 50% interest in each parcel of real property. The A general partnership, either directly or through a management company owned by two of its partners, manages all aspects of the properties.

The A general partnership has 12 general partners. The 12 partners are investment and holding companies which are themselves general partnerships. These investment and holding companies make up the “intermediate tier.” The general partners of the intermediate tier consist of various trusts for the benefit of members of the B and C families, some of which are revocable trusts, and some individual members of the B and C families.

The Articles of Partnership creating the A general partnership were executed in 1969 and amended in 1973. There have been no amendments to the partnership agreement since that time. Certain provisions of the partnership agreement provide a buy-sell agreement among the A partners with respect to their interests in the A general partnership. These provisions restrict the transfer of interests in the A general partnership.

Specifically, under sections 5.11 and 15.01 of the partnership agreement, no partner may sell, transfer, mortgage, pledge, hypothecate or otherwise encumber all or any part of its partnership interest without the consent of 90% (in interest) of the partnership. Under sections 5.11 and 16.01, a new general partner may be admitted only with the consent of 90% (in interest) of the partnership and only after agreeing to perform and comply with all of the provisions of the partnership agreement. Under sections 17.01(b), (c), and (d) and 17.03(a), an attempted transfer (including a mortgage or pledge) of a partnership interest without such consent triggers the A partnership purchase option.

Section 15.01 of the agreement permits the liquidation of an A partner (i.e. a holding or investment company) and/or distribution of an A partner’s interest in A to any trust which was an original partner of the holding or investment company (or to any beneficiary of any such trust) provided that the trust (or beneficiary) agrees to be bound by the terms of the partnership agreement. Thus, the partnership agreement specifically authorizes the distribution of A partnership interests to the trusts and/or the beneficiaries and the substitution of the trusts and/or the beneficiaries as partners in A.

Under section 17.01 of the partnership agreement, as to each holding company, the death of a specified individual (generally the individual who is the current beneficiary of the trust that owns the holding company) is defined as an act of withdrawal and the holding company is thereafter deemed to be a “withdrawing general partner.” Upon any such death, under section 17.03 of the partnership agreement, A is obligated to purchase a 49% interest in the withdrawing general partner (i.e. the holding company) upon death and the remaining 51% not later than 10 years after death. As to the investment companies, under section 17.04 of the partnership agreement, within 90 days of a specified individual’s death (generally the beneficiary of a trust that owns the company), A may elect to purchase the investment company’s interest. If A so elects, the death of the individual is deemed to be an act of withdrawal with respect to the investment company and the investment company whose interest is purchased is deemed to be a withdrawing general partner.

The price for any withdrawing partner’s interest is to be paid in 10 equal annual installments with interest on the unpaid balance at a rate of 4% per year. The A general partnership also has the right to pay the purchase price in full at any time without penalty. The purchase price is payable in cash and is determined with reference to A’s most recent certificate of value. If the most recent certificate of value is dated more than 5 years prior to the date of the act of withdrawal (i.e. the attempted transfer or death), 5% of the value set forth in such certificate of value shall be added to that value for each entire 5-year period from the date of such certificate of value to the date of the act of withdrawal with no proration for any period of less than 5 full years. Section 18.02 of the partnership agreement states: “It is the intention of the general partners to review the value of the partnership and to execute a new certificate of value at least once every 5 years.” The general partners of A last executed a certificate of value in August, 1983.

The partners of the A general partnership propose to place the real estate and the marketable securities in separate entities, as discussed below. The represented purpose of the reorganization is to insulate each parcel of real estate from liabilities that relate to the other parcels, and to limit the personal liability of some of the partners. Placing the marketable securities in a separate entity is similarly intended to remove the securities from exposure to liabilities relating to the real estate.

The A general partnership will distribute its marketable securities pro rata to its partners. The partners will then contribute the marketable securities to a newly created S corporation or partnership in return for proportionate interests in that corporation or partnership.

In addition, most of the real estate parcels owned by the A general partnership will be placed in separate limited partnerships. The A general partnership will distribute to its partners (i.e. the intermediate tier) all but a 1% interest in the real estate parcels. Thus; a 49% interest in each parcel will be distributed to A’s partners. Each intermediate tier company would distribute pro rata to its partners (the trusts and individuals) the interest in real property. The partners will contribute their interests in each such real estate parcel to a newly formed limited partnership created to hold interests in each specific real estate parcel. The A general partnership will act as a general partner in each of the limited partnerships, acquiring its general partnership interest by contributing one-half of its retained interest (i.e. .5%) in each real estate parcel to the corresponding limited partnership. The A general partnership will continue to hold a .5% interest in each real estate parcel.

Thereafter, over a period of 12 to 25 months the intermediate tier companies will liquidate and distribute pro rata their interests in A to their respective partners. Each partner, with the exception of the partners which are trusts of which B is the current income beneficiary, will form an S corporation as described in section 1361 of the Code and contribute to this new corporation its interest in the A general partnership. You represent that all other partners which are trusts are either grantor trusts under section 671-678 of the Code or will be qualified Subchapter S trusts under section 1361(d).

Prior to the distribution of any real estate interests from the A general partnership, the partners will agree to buy-sell provisions which will be a part of the limited partnership agreements and S corporation by-laws. The provisions are intended to apply the restrictions contained in the A partnership agreement to the new entity. For example, the provisions require consent of 90% in interest of the parties to each agreement in order to amend the agreement, make additional capital contributions to the entity, admit a new partner to any partnership, exercise the election to purchase a party’s interest in the entity, or sell, transfer, mortgage, pledge, hypothecate, or otherwise encumber all or any part of a party’s interest in a partnership or S corporation. If the above consent is received, a new partner may be admitted to all, but not less than all, of the partnerships with the same percentage interest in each partnership. The new partner must agree to comply with all of the provisions in the partnership agreement.

The buy-sell agreement defines an act of withdrawal to include an election by any party to withdraw part or all of that party’s interest in any partnership or corporation, the liquidation, distribution, sale, voluntary mortgage, pledge, hypothecation, or other encumbrance of part or all of any party’s interest in a partnership or corporation, and the insolvency of any party. In addition, with respect to the interest owned by certain revocable trusts, the death of a specified individual is treated as an act of withdrawal with respect to that trust. Should any of these acts of withdrawal occur the remaining parties must either liquidate and terminate all partnerships or all remaining partners must purchase the withdrawing party’s interest. The remaining parties shall make the purchase pro rata based on their respective percentage interest in the partnership.

In the case of interests held by certain revocable trusts, on the death of the specified individuals who are current beneficiaries of revocable trusts, owning partnership interests, the remaining parties must purchase 49% of the withdrawing party’s interest upon death in the manner described above. The remaining 51% interest of the deceased withdrawing party may be purchased upon election by all, but not less than all, of the remaining parties during the 10 years following the death of the partner. If the remaining parties shall fail to exercise such election, the expiration of 10 years from the death of the partner shall be deemed to be an act of withdrawal.

With respect to interests held by certain irrevocable trusts, on the death of a specified individual, the remaining partner must purchase those interests within 90 days of the partner’s death.

The determination of the price to be paid for the withdrawing party’s interest as well as the method by which this payment will be made under the new provisions is the same as that under the prior agreements with one exception. The rate of interest to be paid on the 10-year note to the withdrawing party under the new agreement will be the long-term applicable federal rate compounded annually from the date of the act of withdrawal rather than the 4% rate specified in the prior agreement. Other provisions generally parallel those contained in the original A partnership agreement.

For purposes of this ruling request, you ask that we assume, without deciding, that the buy- sell agreement is an agreement, option, or other right to acquire property at less than fair market value that is not within the exception under section 2703(b).

You request that we rule that neither: 1) the execution of a new certificate of value increasing the value of the A general partnership and the use of the AFR instead of a 4% rate of interest on installment payments to withdrawing partners, 2) the reorganization of the A general partnership as described above, nor 3) the application of the A general partnership buy-sell agreement to the reorganized entities as described above will subject the buy-sell agreement to section 2703 of the Code.

Section 2703 of the Code was enacted as part of section 11,602 of the Omnibus Reconciliation Act of 1990, Pub. L. 101-508, 104 Stat. 1383. Section 2703 provides that, for purposes of the estate, gift, and generation-skipping transfer taxes, the value of any property is determined without regard to any right or restriction relating to the property. A right or restriction includes any option, agreement, or other right to acquire or use the property at a price less than fair market value determined without regard to the option, agreement, or right, or any restriction on the right to sell or use the property. Section 2703 applies to any right or restriction created or substantially modified after October 8, 1990. Section 2703(b) provides an exception to imposition of section 2703(a) for a right or restriction where:

1. the right or restriction is a bona fide business arrangement,

2. the right or restriction is not a device to transfer the property to the natural objects of the transferor’s bounty for less than adequate and full consideration in money or money’s worth, and

3. at the time the right or restriction is created, the terms of the right or restriction are comparable to similar arrangements entered into by persons in an arms-length transaction.

You have asked us to assume, for purposes of this ruling, that the buy-sell agreement incorporated in the A general partnership provisions does not qualify under section 2703(b).

A right or restriction that is substantially modified is treated as a right or restriction created on the date of the modification. Any discretionary modification of a right or restriction, whether or not authorized by the terms of the agreement, that results in other than a de minimis change to the quality, value, or timing of the right or restriction is a substantial modification. Such occurrences as the failure to update a right or restriction where it is required, or the addition of a family member as a party to a right or restriction, is considered a substantial modification unless it can be shown that updating would not have resulted in a substantial modification, or the addition of the family member is mandatory under the terms of the right or restriction.

Certain modifications are not considered substantial for purposes of section 2703. A modification of a capitalization rate used with respect to the right or restriction, if the rate is modified in a manner that bears a fixed relationship to a specified market interest rate, is not considered a substantial modification. In addition, a modification that results in an option price that more closely approximates fair market value is not considered a substantial modification.

If the new certificate of value which you propose to obtain more closely approximates the current fair market value of the entities and it is the intention of the parties, as specified in the new as well as the prior buy-sell agreement, that this certificate of value be updated every 5 years, obtaining a new certificate of value would not be a substantial modification of the buy-sell agreement. Similarly, a change in the interest rate on installment payments paid on a withdrawing partner’s partnership interest from the current 4% to the AFR will not be a substantial modification.

Under the proposed reorganization in the instant case, each party will continue to own the same proportionate share of the real estate parcels after the reorganization as it did prior to the reorganization. The proposed buy-sell agreement will apply to the new limited partnerships and S corporations and will produce the same results as would occur if the buy-sell agreement were exercised in the A general partnership.

We conclude that neither the execution of a new certificate of value increasing the value of the A general partnership, the use of the AFR instead of a 4% rate of interest on installment payments relating to the buy-sell agreement, the reorganization of the A general partnership as described above, nor the application of the proposed buy-sell agreement to the reorganized entities as described above will subject the buy-sell agreement to section 2703 of the Code.

This ruling is based on the facts and applicable law in effect on the date of this letter. If there is a change in material fact or law (local or Federal) before the transactions considered in the ruling take effect, the ruling will have no force or effect. If the taxpayer is in doubt whether there has been a change in material fact or law, a request for reconsideration of this ruling should be submitted to this office.

This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent. Final regulations pertaining to one or more of the issues addressed in this memorandum have not yet been adopted. Therefore, to the extent that regulations are adopted that are inconsistent with any conclusion herein, this memorandum will be modified. See section 9.03 of Rev. Proc. 91-2, 1991-1 I.R.B. 38. However, when the criteria in Section 9.04 of Rev. Proc. 91-2 are satisfied, a ruling is neither revoked nor modified retroactively except in rare of unusual circumstances.

Technical Advice Memorandum
Number: 9127007
Internal Revenue Service
March 26, 1991

Symbol: TR-32- 263-90

NATIONAL OFFICE
TECHNICAL ADVICE MEMORANDUM

Uniform Issue List Nos.: 2035.00-00, 2042.00-00

ISSUE

Are the proceeds of a life insurance policy on the decedent’s life includible in the decedent’s gross estate under section 2035 of the Internal Revenue Code when, within 3 years of the decedent’s death, the policy is assigned by a corporation in which the decedent owned 50 percent of the outstanding shares (and from which the decedent had the option to acquire the policy outright) to an irrevocable trust created by the decedent?

FACTS

The decedent’s revocable trust and A each owned 50 percent of the outstanding shares of a corporation. On October 15, 1985, the two share-holders and the corporation executed a buy-sell agreement. The agreement provided that the corporation was to purchase the shares owned by A in the event of A’s death and the shares owned by the revocable trust in the event of the decedent’s death.

The buy-sell agreement permitted the corporation to purchase life insurance on the lives of A and the decedent in order to carry out its obligations under the agreement. The agreement also provided that the corporation was to pay the premiums and own the policies in the event that life insurance was so purchased. Paragraph 25 of the buy-sell agreement provides as follows:

Each SHAREHOLDER, if living, upon the termination of this AGREEMENT or upon sale of either’s CAPITAL STOCK during his lifetime, and following full payment of the purchase price for said CAPITAL STOCK, shall have the right to purchase from the CORPORATION the policies of insurance on his life held by the CORPORATION hereunder, for a price equal to the cash surrender value of the policy or policies, plus any accumulated dividends, less the amount of any policy loan then outstanding. This right shall be exercisable by payment of the purchase price for said policy or policies in cash to the CORPORATION within ninety (90) days following the date of the termination of this AGREEMENT, or full payment for any CAPITAL STOCK of said STOCKHOLDER pursuant to this AGREEMENT, or upon such earlier time as the parties may agree upon. Upon receipt of the purchase price, the CORPORATION shall deliver the policies to the purchaser and shall execute any necessary documents to effectuate a transfer of ownership and/or change of beneficiary designation. The insured shall have no further right in any policy not purchased within such ninety (90) day period and the CORPORATION may thereafter surrender the policy for its cash value or dispose of it in any other way it sees fit.

Shortly after the execution of the buy-sell agreement the corporation purchased insurance of the lives of A and the decedent. The face amount of each policy was $750,000.

The decedent underwent surgery for lung cancer in the latter part of the summer of 1987. The cancer was inoperable.

On December 30, 1987, the decedent created an irrevocable trust for the benefit Of his children and former spouse.

On February 3, 1988, the two shareholders executed an amendment to the October 25, 1985 buy-sell agreement that provided that the parties were to use their best efforts to effectuate a sale of the corporation and that the buy-sell agreement was terminated as of February 3, 1988.

On February 3, 1988, the decedent caused the corporation to execute a document that assigned all right, title and interest in the policy insuring his life to the irrevocable trust that he had created on December 30, 1987. In the same instrument the corporation also designated the irrevocable trust as the beneficiary of the policy. At or about the same time, the corporation also assigned ownership of the policy insuring A ‘s life to A .

The decedent died from cancer in May 1988.

After the decedent’s death A and the corporation sued the irrevocable trust, the revocable trust, the decedent’s estate, and others, alleging that A and the corporation were fraudulently induced by the decedent to terminate the buy-sell agreement and to transfer ownership of the policy owned by the corporation on the decedent’s life to the irrevocable trust. A received $100,000 upon the settlement of the suit.

LAW AND ANALYSIS

Section 2035(a) of the Code provides that the gross estate includes the value of all property to the extent of any interest therein of which the decedent has made a transfer within 3 years of death. Section 424(a) of the Economic Recovery Tax Act of 1981, 1981-2 C.B. 256, 332, added section 2035(d) to the Code. Section 2035(d)(1) generally limits the application of section 2035(a) to estates of decedents dying before 1982. However, certain transfers by decedents dying after 1981 remain subject to the 3-year inclusion rule. Under section 2035(d)(2), section 2035(a) continues to apply to a transfer of an interest in property which is included in the value of the gross estate under sections 2036, 2037, 2038 or 2042 or would have been included under any of those sections if the interest had been retained by the decedent until death.

Section 2042(2) of the Code provides that the value of the gross estate includes the value of the amount receivable as insurance under policies on the life of the decedent by beneficiaries other than the executor, with respect to which the decedent possessed at death any of the incidents of ownership, exercisable alone or in conjunction with any other person.

Section 20.2042-1(c)(2) of the Estate Tax Regulations provides that the term “incidents of ownership” is not limited in its meaning to ownership of the policy in the technical legal sense. The term includes, for example, the power to change the beneficiary, to surrender or cancel the policy, to assign the policy, to revoke an assignment, to pledge the policy for a loan, or to obtain from the insurer a loan against the surrender value of the policy, etc.

Section 20.2042-1(a)(2) of the regulations provides that proceeds of life insurance that are not includible in the gross estate under section 2042 of the Code may, depending upon the facts of a particular case, be includible under some other section of the estate tax provisions of the Code. For example, if the decedent possessed incidents of ownership in an insurance policy on the decedent’s own life and gratuitously transferred all rights in the policy within 3 years of death, the proceeds would be includible under section 2035.

The inclusion of life insurance proceeds under section 2042 of the Code depends on the decedent’s possession of incidents of ownership of the policy at death. However, the inclusion of life insurance proceeds under section 2035(d)(2) is based on a different rule. Section 2035(d)(2) will apply if the decedent transferred an incident of ownership in the life insurance policy during the 3-year period before death.

It is fundamental that substance prevails over form for purposes of determining the federal estate tax consequences of a transaction. United States v. Grace , 395 U.S. 316 (1969). See also Gregory v. Helvering , 293 U.S. 465 (1935). The transaction in the subject case constitutes, in substance, a distribution of the policy from the corporation to the decedent (in his capacity as settlor of the shareholder revocable trust), followed by an immediate transfer or assignment of the policy from the decedent to the irrevocable trust that he had created.

In this regard, it is obvious that the transaction was not a gratuitous transfer by the corporation to the irrevocable trust. The corporation was not in a position to give the decedent’s policy to anyone without the decedent’s express consent. Rather, the corporation assigned the policy to the irrevocable trust in satisfaction of an obligation to one of its shareholders (the decedent’s revocable trust). The corporation’s obligation was to distribute the policy to the decedent’s shareholder trust pursuant to paragraph 25 of the buy-sell agreement because the shareholder (the decedent’s revocable trust) exercised its option to acquire the policy once the buy-sell agreement terminated by reason of the February 3, 1988 agreement. (We note here that a similar analysis would apply if the corporation had decided to make a pro rata distribution of the policies to the shareholders with respect to their stock, e.g., as a dividend or a return of capital.) Instead; however, the decedent, through his revocable trust, made a specific request to the corporation to distribute the policy to ‘the irrevocable trust. The corporation complied with the decedent’s request and distributed the policy to the irrevocable trust, thereby discharging the corporation’s obligation to distribute the policy to the decedent’s revocable trust.

In the absence of the decedent’s special request, the irrevocable trust had no right to the policy either as a shareholder or as a purchaser. Nor can the transfer to the irrevocable trust be considered as a gift from the corporation under the facts of this case. It was the decedent through his revocable trust who bad the right to the policy as the consequence of the February 3, 1988 termination of the buy-sell agreement and pursuant to the express provisions of that agreement. (If the two shareholder’s policies had been disposed of by the corporation in the absence of a termination of the buy-sell agreement, the decedent’s policy would likewise have been distributable solely to him and in his capacity as a shareholder because the other policy was distributed to A .)

There is no contention made by the estate that the decedent disclaimed or attempted to disclaim the policy and that the policy was distributed by the corporation to the trust as a result of such a disclaimer. Indeed, an attempted disclaimer of the policy by the decedent would have failed under section 2518 of the Code for a number of reasons the most significant of which were (1) that the decedent had for more than 9 months been the owner of a one-half interest in the corporation (and as a one-half owner was entitled to the policy on his own life in the event of a termination of the buy-sell agreement) and (2) that the decedent did not merely allow the policy to “fall” to a successor beneficiary. Section 2518(b)(4) provides, in part, that as a result of the disclaimer the interest disclaimed must pass ” without any direction on the part of the person making the disclaimer.” (Emphasis added.) In the present case the decedent in fact directed the corporation to assign the policy to the irrevocable trust. Thus, for purposes of section 2518, the decedent would be deemed to have accented the policy in the first instance in order to have caused the policy to be transferred to the irrevocable trust.

The concept of acceptance in this instance is not peculiar to section 2518 but is instead a generic property law concept that is inherent to the common law as reflected in state court decisions’ on disclaimer litigation throughout the country. The assignment of property presupposes that the property (the insurance policy in this case) has been accepted in the first instance. In fact, the very act of assignment or conveyance of property may also constitute the act of acceptance of the property. See 6 Page on Wills § 49.9 (1962) at note 21.

The estate claims that the decedent’s insurance policy had a zero cash surrender value on February 3, 1988. (The policy would in any event have had a substantial “book”, reserve value on that date and, considering the decedent’s terminal illness at that time, would have had a much greater actual value.) The estate explains that, under the buy-sellagreement terms, there would have been no requirement for the decedent to provide any payment in exchange for a distribution of the policy to the decedent.

Whether the cash surrender value of one or both shareholder’s policies was zero or whether both shareholders simply agreed to mutually waive any payment for the cash surrender values is not apparent and for that matter, is not material. The fact would remain under either scenario that the decedent possessed a fully enforceable contractual right under the buy-sell agreement to receive an immediate distribution of this insurance policy on February 3, 1988.

Thus, the decedent either exercised his right to purchase the policy from the corporation for its cash surrender value or received the policy as a distribution from the corporation with respect to his stock (i.e., as either a dividend or as a return of capital under section 301 of the Code). However, for present purposes, we view this distinction as a distinction without a difference. For example, see Rev. Rul. 79-46, 1979-1 C.B. 303, to the effect that, under certain circumstances, even an unexercised option to purchase a life insurance policy will constitute an incident of ownership. See generally, Epstein v. Commissioner , 53 T.C. 459 (1969), to the effect that a gratuitous transfer from a shareholder’s corporation directly to a shareholder’s trust is a constructive distribution from the corporation to the shareholder. See also J.G. Spitz Trust v. Commissioner , T.C. Memo. 1971-8, to the same effect. The critical fact is that the decedent, in effect, acquired ownership of the policy (either by exercise of his right to purchase or by way of a corporate distribution with respect to his stock) and then transferred ownership of the policy by assignment within 3 years of his death.

We have considered Rev. Rul. 82-141, 1982-2 C.B. 209; Rev. Rul. 90-21, 1990-1 C.B. 172, and section 20.2042-1(c)(6) of the regulations which contain rules that attribute, in certain circumstances, a corporation’s incidents of ownership in a policy insuring a controlling shareholder’s life to the controlling shareholder (meaning a shareholder who possesses more that 50 percent of the voting power of the corporation). The regulation and the revenue rulings are inapposite to this case because the decedent did not own more than 50 percent of the voting power. Our conclusion in this case is based upon the fact that when the decedent and A executed the February 3, 1988 agreement that terminated the buy-sell agreement, the decedent acquired possession of the incidents of ownership in his own right (as distinguished from having been deemed to own whatever incidents of ownership the corporation owned by reason of an attribution rule based upon stock ownership). If the decedent had died on February 2, 1988, he would have held no incidents of ownership in the policy (as a mere 50 percent shareholder) and nothing would have been includible under section 2642. But if the decedent had died on February 3, 1988, after executing the termination of the buy-sell agreement and before directing the corporation to assign his policy to the irrevocable trust, his acquisition of the incidents of ownership would have required inclusion of the proceeds of the policy under section 2042.

We have also considered cases such as Estate of Headrick v. C.I.R ., 918 F.2d 1263 (6th Cir. 1990), aff’g 93 T.C. 171 (1989) and Estate of Leder v. C.I.R ., 893 F.2d 237 (10th Cir. 1989), aff’g 89 T.C. 235 (1987), which pertain to the inclusion of life insurance proceeds under section 2035 of the Code with respect to decedents who die after 1981. As previously indicated, the 3 year inclusion rule in section 2035(a) continues to apply to certain transfers made by decedents who die after 1981, including a transfer of an interest in property which is included in the value of the gross estate under section 2042 or which would have been included under that section if the transferred interest had been retained by the decedent until death.

In Headrick , the decedent established an irrevocable inter vivos trust with a bank as trustee. The trust agreement authorized, but did not require, the trustee to hold and/or acquire insurance on the decedent’s life. The agreement also provided that the trustee must own each policy purchased by, or contributed to, the trust and shall exercise each incident of ownership over the policy. The trustee purchased such a policy, and the decedent made annual contributions to the trust in amounts sufficient to meet the trusts monthly premium obligations. The decedent died within three years from the time that the trustee purchased the policy. It was held that the insurance proceeds were not includible in the decedent’s gross estate under sections 2035(a) and (d)(2) of the Code because the decedent never possessed any of the “incidents of ownership” (within the meaning of section 2042) in the policy. A similar result was reached in Leder .

In Leder , the decedent’s wholly owned corporation paid, directly to the insurance company, all of the premiums on a policy on the decedent’s life that his wife had purchased within three years of his death.

In determining the applicability of section 2035 after the 1981 amendments, cases such as Headrick and Leder have held, in essence, that the first step is to determine whether the decedent possessed an incident of ownership in the policy within 3 years of death that would have caused an inclusion in the decedent’s gross estate under section 2042 had the interest been retained until death. In other words, the first inquiry is whether section 2035(d)(2) applies. The reason for this is that unless section 2035(d)(2) applies to negate the operation of section 2035(d)(1), the latter section will operate to eliminate the operation of the 3 year inclusion rule contained in section 2035(a). In Headrick and Leder it was concluded that the “beamed” or “constructive” transfer theories applied in cases such as Bel v. United States , 452 F.2d 683 (5th Cir. 1971) and Estate of Kurihara v. Commissioner , 82 T.C. 51 (1984) (i.e., cases concerned with whether decedents who died prior to 1982 had made a “transfer” within the meaning of section 2035(a)) are not germane to the initial (first step) inquiry as to whether the decedent possessed an incident of ownership within the 3 year period. If it is first determined that the decedent in fact possessed the necessary incident of ownership within the 3-year period, the second step is to determine whether the decedent made a “transfer” of that incident of ownership within the 3 year period within the meaning of section 2035(a). For purposes of this second step, a “transfer” may include a “beamed” or “constructive” transfer ala Bel and Kurihara.

Although the Service does not necessarily concur with the conclusions reached in Headrick and Leder , our conclusion here is consistent with the reasoning expressed in those cases concerning the criteria for includibility with respect to decedents who die after 1981. Although the decedent in this case had not acquired incidents of ownership in the policy before February 3, 1988, he did acquire all of the incidents of ownership on that day, thus taking the first step of the Tax Court’s two step test. The decedent took the “second step” when he directed the assignment of the policy to the irrevocable trust on the same day.

Thus, the present case is factually distinguishable from the Leder and Headrick cases. In the present case the decedent had an absolute right to acquire the policy, and the corporation had an unequivocal obligation to assign the policy to the decedent (through the revocable trust). In Leder and Headrick the decedent never had a right to receive the insurance policy even though he signed the application for the policy and furnished the money to pay the premiums to the insurance trust ( Headrick ) or paid the premiums directly to the insurance company ( Leder ).

CONCLUSIONS

For the reasons discussed above, we conclude that (1) the decedent possessed incidents of ownership in the policy and (2) effectively transferred those incidents of ownership Within 3 years of his death. Accordingly, the proceeds of the policy are includible in the value of the decedent’s gross estate under sections 2035(a) and (d) of the Code.

A copy of this technical advice memorandum is to be given to the taxpayer. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.