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"Are Life Insurance Proceeds Taxable?" 

 

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Estate Planning Update
November 2011
Greetings!

Life insurance is an integral part of planning for your family's financial security after you're gone. Consequently, it is vital to understand how and when the proceeds may be taxed. Otherwise, your loved ones may be left with substantially less financial support than you intended.

Are life insurance proceeds subject to income tax?

 

* Life insurance proceeds are specifically excluded from a beneficiary's taxable income under the Tax Code. However,...

 

Are life insurance proceeds subject to estate tax? 
 
* If the proceeds are receivable by the insured's estate, or if the insured possessed any "incidents of ownership" in the policy - e.g., the ability to change the beneficiaries or borrow against the policy - within 3 years of his or her death, the proceeds are subject to tax in the insured's estate.

* On January 1, 2013, the estate tax exemption amount is scheduled to drop from $5M to $1M; and the estate tax rate is scheduled to rise from 35% to 55%. Therefore, if an insured possesses any incidents of ownership in the policy (as most do) and dies after the transfer tax laws change, the surviving family members may receive less than half of the proceeds after the estate tax has been paid.

Is there a solution?
 
* Yes! If the insured eliminates (or, preferably, never possesses) all incidents of ownership in the policy sufficiently far in advance, the proceeds will not be subject to estate tax. The best way to prevent inclusion of life insurance proceeds for estate tax purposes is by holding the policy in an Irrevocable Life Insurance Trust (ILIT).

* There are a number of important procedural steps that must be done correctly in creating an ILIT (especially where there are separate policies on the lives of a married couple), transferring an existing policy to an ILIT, purchasing a new policy in an ILIT, and paying the annual premiums on a policy held in an ILIT, which require the assistance of an experienced and knowledgeable estate planning attorney.

Please contact me at 323.654.9513 or brookspaley@paleylaw.com if you would like to discuss your current estate plan.

Brooks Paley, J.D., LL.M.
About Paley Law Corporation
Brooks 0168

Paley Law Corporation is based in Los Angeles and specializes in providing personalized, sophisticated estate planning and related legal services.  Brooks Paley, J.D., LL.M., is the managing principal of Paley Law.  Brooks is quoted in the June/July 2011 issue of Working Ranch Magazine ("Death Tax Tips") on the impact of the estate tax on family-owned businesses and tax planning opportunities available to them.

The above material is provided for general informational purposes only and is not intended to constitute legal advice in any particular matter. Transmission of this material does not create an attorney-client relationship. Paley Law Corporation does not warrant the content of this material and is not responsible for any errors or omissions associated with it.

To ensure compliance with requirements imposed by the Internal Revenue Service, Paley Law Corporation informs you that any U.S. tax advice contained in this communication (including any links to other websites or material) is not intended to be used, and cannot be used, for purposes of (i) avoiding penalties imposed under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

    

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2011 Paley Law Corporation