A judge said he remains unsure how to rule following a four-day trial in which the IRS accused a taxpayer of using life insurance policies to avoid estate taxes.
“I look forward to your briefs because for me this is going to be a hard case,” said U.S. Tax Court Senior Judge Joseph Goeke on Oct. 11, at the end of the trial.
The issues remaining 5.5 years into the case are whether six life insurance policies at their cash surrender value—what would be gotten from cashing them out—must be included in the deceased woman’s taxable estate and whether the estate is liable for tax underpayment penalties. The policies were purchased for $30 million.
If the court finds the estate underpaid taxes, it must further decide whether the estate is liable for a 20% tax addition penalty under Section 6662.
The final ruling could also dictate the overall attractiveness for estate planners of an arrangement at the center of the case called a split-dollar arrangement—made between parties to split the cost and benefit of a life insurance policy, where a party paying premiums gets an interest in the payout.
The estate in the case is connected to a set of family businesses, described in court documents as the “Interstate Group,” which were accumulated in the decades after Arthur Morrissette started a moving company, Ace Van & Storage, in 1943.
Arthur’s surviving wife, Clara Morrissette, used her revocable trust to transfer $29.9 million to three trusts for the benefit of each of her three sons in 2006. Those trusts then used the funds to make lump-sum payments for six permanent life insurance policies. This meant each son’s trust held a policy that insured the lives of the two other sons.
These transactions were governed by split-dollar arrangements between Clara’s revocable trust and her son’s trusts—whenever an insured son died or an arrangement was terminated, Clara’s trust would get either a policy’s cash-surrender value or all the premium payments made on it, whichever was greater. If the policy remained in place until an insured son died, Clara’s payout would be taken out of the death benefit, and the sons’ trusts would receive any remaining death benefit.
Motivation for $30 Million Transfer
Figuring out the motivation for entering into the split-dollar arrangements was a thorny issue at trial.
In order to exclude the cash-surrender value of the life insurance policies from the taxable estate, tax rules—tax code Sections 2036, 2038, and 2703—require demonstration of a bona fide sale or business transaction, meaning there needs to have been a significant non-tax reason for the arrangements.
Counsel for the IRS argued that the “primary motivation” for entering into these split-dollar arrangements was to lower anticipated estate taxes, where having to wait to be repaid until the sons passed away lowered the present-value of the rights Clara’s trust received in exchange for the $30 million.
The agency highlighted that the Morrissette family was told through written communications in advance that they could save several million dollars in taxes through entering into the arrangements.
Kenneth Morrissette, one of Clara’s sons, said the family entered into the arrangements so that money from a policy’s death benefit would help the surviving sons to buy each other’s shares at the time of their deaths while also repaying their mother. He also said the policies paid a better return than the family was obtaining by having the $30 million sit in investment accounts.
According to a 2006 shareholders agreement, when one of the brothers died any surviving brother would have to buy the Interstate Group stock that was held by or for the benefit of the deceased brother.
A Realistic Business Exchange
If the Morrissette estate’s argument about its motivations prevails, the tax code’s provisions— Sections 2036, 2038, and 2703—also require proof that Clara Morrissette’s trust received something that was worth the $30 million she put in. Specifically, they require that the transaction was a “full and adequate” exchange that parties who are unrelated to each other would have entered into.
On this issue, experts debated what was the best real-world exchange with which to compare the split-dollar arrangements.
Shishir Khetan, an expert for the Morrissette estate, pointed to data on life settlements—where a life insurance policy is sold to a third party—as a reliable comparison specifically for assessing the value of what Clara’s trust had the right to receive under the arrangements. Khetan is managing director in the valuation advisory group of advisory and consulting firm Stout. He said he researched a number of sources to understand the rates of return from life settlements.
But the IRS’s expert witness, Francis Burns, questioned whether enough is known about life settlements to make a reliable comparison. “There’s nothing in the marketplace for which you can get transparent data on life settlement transactions to guide you in this process,” he said. Burns is a Principal with Global Economics Group LLC.
Burns instead compared split-dollar agreements he found through public filings. But counsel for the Morrissette estate highlighted that all the agreements Burns found were between employers and employees, unlike with the Morrissette arrangements.
More to Come
The 20% tax addition penalty under Section 6662 applies to any portion of underpayment that’s attributable to negligence or disregard of rules, among other causes.
The parties will have until Jan. 21, 2020, to file post-trial briefs in the case, with replies to those briefs due March 9 of that year.
Reed Smith LLP represented Clara Morrissette’s estate.
The case is Estate of Morrissette v. Commissioner, T.C., No. 4415-14, trial concluded 10/11/19.