Use of Life Insurance in Private Foundations - Continuing a Legacy

Use of Life Insurance in Private Foundations - Continuing a Legacy

Article posted in Intangible Personal Property on 14 September 2010| comments
audience: National Publication | last updated: 2 March 2012
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Summary

It's a well known fact that life insurance is one of the most efficient assets in creating an estate when it is needed. It is also common to such contracts to be owned by public charities. In this article, Peggy M. Hollander, Managing Partner of the Succession Group, reviews the issues and opportunities that surround the ownership of life insurance by private foundations.

By Peggy Hollander, Managing Partner The Succession Group

A private foundation can be used to create a philanthropic legacy. One way to leverage assets in a private foundation is through the use of life insurance. The private foundation may own life insurance, not only on a public donor, but may also be able to own insurance on foundation employees or board of directors.1 There are several issues which the client’s legal counsel must address. In general, a private foundation needs to be wary of excise and penalty taxes under the Internal Revenue Code (IRC). A client should speak to their legal and/or tax advisor prior to taking any action to ensure it is appropriate for their particular situation.

Private Letter Ruling (PLR) 200232036 can provide additional guidance regarding the issues of a private foundation that owns life insurance on the founder, substantial contributor, or director of a private foundation.2

First, the PLR discussed the issue of private inurement. Private inurement means that the private foundation may not be organized or operated in a manner that provides benefits to a private interest, such as an individual. The foundation must be organized and operated exclusively for one or more exempt purposes. One method to avoid the issue of private inurement is for the foundation to hold all incidents of ownership of the life insurance policy and be in complete control of the policy both economically and legally.

Second, the private foundation should avoid the self-dealing issue under IRC §4941. A tax will be imposed on any act of self-dealing between a “disqualified person” and a private foundation, whether by sale, exchange, lending of money or furnishing of goods and services. Generally, a disqualified person is a natural person or entity that is, or is related to, a “substantial contributor”, “foundation manager” or a 20% owner of the voting power of a corporation, partnership or enterprise that is, itself, a substantial contributor.3

Lastly, there must not be a likelihood that the insured (a disqualified person), their heirs, creditors or assignees can benefit from the transaction or the policy. As previously stated, if the private foundation holds all incidents of ownership in the life insurance contract, this may avoid the appearance of self-dealing. In addition, if the insured sits on the Board of Directors, it may be appropriate to relinquish all ability to vote on any issues relating to the insurance policy on the insured’s life. If an existing policy is gifted to the foundation, the policy should generally not have any outstanding loans. The donor may promise to contribute the future premiums to the foundation. If this is followed, the donor should not require that the contribution be used for the policy premium or that the policy must be kept in force.

Furthermore, a tax will be imposed, under IRC §4944, on any investment that jeopardizes a private foundation’s exempt purposes based on the facts and circumstances at the time of investment. To avoid jeopardizing an investment, the donor should not receive anything in return for the gift of the policy or cash. The donor may give assurances that they will continue to pay the premiums. Generally, the death benefit from the contract will provide a benefit greater than the cost of the premium.

A taxable expenditure under IRC §4945 is a tax imposed on amounts paid that do not promote or further the qualified charitable purposes. To avoid this, the foundation should be the sole and unconditional beneficiary of all of the life insurance benefits and death proceeds. Second, the payment of premiums should not be considered taxable as long as the investment is for the purpose of obtaining funds in furtherance of the foundation’s charitable intent. It may be beneficial to specify how the insurance proceeds will be used in furtherance of the charitable purpose in the minutes of the foundation.

There are many issues that need to be addressed when a private foundation owns insurance on a “disqualified person”. This does not mean, however, that insurance in a private foundation is disallowed; rather, the issues relevant to a private foundation must be addressed to ensure that unintended consequences do not arise.

Methods to donate life insurance to a private foundation

Generally, there are three methods used to provide a private foundation with the benefits of a life insurance contract. First, the donor (insured) may designate the charity as the beneficiary of an existing life insurance policy. The private foundation does not own the life insurance policy. Thus, the policy is included in the estate of the insured, because the insured retains all incidents of ownership. At death, the proceeds will pass to the private foundation and the estate may receive up to a 100% charitable estate tax deduction.

Second, a gift of a paid-up policy may provide tremendous benefits to the private foundation. The donor may gift a life insurance policy to the charity during the donor’s life. Here, the charity is the owner and the beneficiary. Generally, the value of the gift is equal to the cash value of the insurance policy.

However, if the policy is not paid-up, the donor may still gift the life insurance policy to a charity. The deduction for a charitable contribution of a life insurance policy is limited to the taxpayer's adjusted basis in the policy or, if less, the policy's fair market value. If the policy is given away and the cash surrender value exceeds the total premium payments, only the total premium payments (less any policy loans or withdrawals) are deductible as a charitable gift.

Finally, a private foundation may purchase a new life insurance contract on the donor. Each state has different requirements regarding "insurable interests" associated with the right of the charitable recipient to purchase a policy on a donor’s life. The donor may either pay the premiums directly to the insurance company or contribute the premiums to the private foundation that, in turn, will pay the insurance company. In some states, it may be possible for the private foundation to not only own the life insurance policy, but also pay the premiums in order to fund the foundation after the donor’s death.4 It is generally more beneficial for the donor to contribute the premiums to the private foundation. The donor may receive a deduction of up 30% of his or her adjusted gross income (AGI) for his or her contribution for premiums given to the private foundation versus the 20% AGI maximum deduction if the donor pays the insurance company directly.5

The use of life insurance to meet the client’s philanthropic goals may be beneficial to the private foundation as long as the applicable laws are followed, carefully avoiding unintended consequences. Individuals who gift or bequeath for charitable purposes have charitable intentions. By using life insurance, the donor may use their charitable intentions to leave a legacy.

Endnotes

1 A private foundation must have an insurable interest on the donor. Please see your state’s specific law.

2 Private letter rulings are only intended for the parties to whom it was addressed, but they can provide some indication of how the Service may rule given a particular set of facts. Private letter rulings do not provide authority for a particular action and do not set precedent.

3 A disqualified person can also include a spouse, ancestor, child, grandchild or great-grandchild of the prior named persons. Also, a corporation, partnership, trusts or estate of which the prior named persons, including family members, own more than 35%. A “disqualified person” is defined in IRC §4946(a)(1).

4 Please see your specific state law.

5 This is because premiums paid directly to the insurance company are considered gifts "for the benefit of" charity rather than "to" the charity. In addition, by making contributions directly to the foundation, it will simplify the process of obtaining a contemporaneous written acknowledgment from the foundation, which is required for charitable deduction substantiation purposes. Furthermore, should the contributions be examined by the IRS in audit, gifts made to the foundation will simplify the auditor's job of verifying the contributions were indeed made for charitable purposes. From the donor's perspective, it is far easier to substantiate a charitable gift when a is check written to a qualified charity as opposed to an insurance company. For these reasons, it is recommended that premium gifts always be made to the charity.

In addition, death benefits that are passed to the private foundation from policies which the donor retained any incidents of ownership can receive up to a 100% charitable estate tax deduction.

A gift of a paid up policy to a private foundation (owned for less than one year) may receive a charitable income tax deduction up to 30% AGI, based on lesser of basis or the fair market value of the contract.

Cash donation of premiums used to purchase a new policy, which the private foundation is owner and beneficiary, may receive a charitable income tax deduction up to 30% AGI.


This article was provided by Peggy M. Hollander, Managing Partner of the Succession Group. Peggy provides sophisticated insurance strategies for estate, business and charitable planning. Peggy can be reached at 305.447.0070, or via e-mail at phollander@succession-group.com.

Peggy M. Hollander is a registered representative and investment advisor representative who offers securities and investment advisory services through AXA Advisors, LLC (NY, NY 212-314-4600), member FINRA/SIPC, and is an agent who offers annuity and insurance products through AXA Network, LLC and/or its insurance agency subsidiaries. AXA Network, LLC does business in California as AXA Network Insurance Agency of California, LLC and, in Utah, as AXA Network Insurance Agency of Utah, LLC. AXA Advisors and AXA Network are affiliated companies and do not provide tax or legal advice. Representatives may transact business, which includes offering products and services and/or responding to inquiries, only in state(s) in which they are properly registered and/or licensed. Your receipt of this e-mail does not necessarily indicate that the sender is able to transact business in your state. California License number 0762969. The Succession Group is not a registered investment advisor and is not owned or operated by AXA Advisors or AXA Network.

Please be advised that this document is not intended as legal or tax advice. Accordingly, any tax information provided in this document is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer. The tax information was written to support the promotion or marketing of the transaction (s) or matter (s) addressed and you should seek advice based on your particular circumstances from an independent tax advisor.


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