By: Martin M. Shenkman, CPA, MBA, JD
So many readers loved the recent checklist column on reasons to buy life insurance, that I have put an encore in this month’s newsletter (yeah, they were probably all insurance agents, but so what!). Here is a creative technique that can be used for estate planning with insurance. It can help advisers that sell insurance close a transaction. Most large life insurance policies are structured to be owned by insurance trusts (ILITs) to avoid taxation in the decedent’s estate. When the insured dies, the ILIT cannot pay estate taxes directly, so the ILIT can loan funds to the estate, or buy assets from the estate. Either approach provides the estate with the use of the cash received from the insurance proceeds. If the ILIT loans the estate the money, and the note mandates that the loan cannot be repaid or accelerated so that the estate must, in all events, pay all the interest required under the note, the estate may qualify to deduct all of the interest to be paid back to the ILIT as an administrative expense. This special type of loan is called a “Graegin Loan”, after the court case that first sanctioned it. So not only can the insurance proceeds be used to pay estate tax on the family business (do not try this with a securities FLP), it may also generate a huge estate tax deduction thereby reducing the estate tax it is helping to pay! This is a great way to plan and close an insurance sale. Planning pointers: Read the footnotes to the Graegin case when planning the transaction-the forms used by some planners are dangerously deficient. Carefully craft default provisions to simultaneously provide protection, yet not void the mandate that the interest be paid. Consider usury issues in the event of a default.
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