In my last post I wrote about grandfathered life insurance policies and their role in reducing the overall tax to an estate where the deceased owned private company shares at the time of death.
Before the introduction of certain “stop loss” rules, it was commonplace for the estate of the deceased to dispose of corporate shares with no income taxes by means of a corporate redemption of the shares. In the preferred situation, the deemed capital gain realized on death was fully offset by a capital loss incurred by the estate on the redemption of the shares and a carryback of the loss. The deemed dividend on redemption was satisfied by a tax-free capital dividend payment of the life insurance proceeds received by the corporation on the death of the shareholder. The stop-loss rules essentially put an end to this ideal situation by grinding the capital loss available for carryback to the date-of-death return.
When the stop-loss rules were enacted, they contained grandfathering provisions that provided relief on dispositions of shares pursuant to “grandfathered agreements” or related to “grandfathered insurance policies.”
For a disposition of a share to meet the grandfathered insurance policy rule, the following conditions must be met:
• the shares were owned by an individual (excluding a trust, but including a trust under which an individual other than a trust is a beneficiary) on April 26, 1995;
• on April 26, 1995, a corporation was the beneficiary of a life insurance policy on the life of the individual or the individual’s spouse;
• the main purpose of the insurance was to fund the redemption, acquisition, or cancellation of the shares by the corporation that issued the shares; and
• the shares are disposed of by the individual, the individual’s spouse, or the estate within the first taxation year, or, in the case of a spousal trust, within three years of the original spouse’s death.
As can be seen, the tests apply as of the date on which the rules changed. Therefore, it is imperative that nothing be done to jeopardize the status of a grandfathered share in order to preserve the preferred tax treatment.
My next entry will address the grandfathered agreement rule. In the interim keep an eye out for grandfathered insurance policies and possibly benefit from a lower estate tax bill.
