In Estate of Becker v. Commissioner, the Tax Court ruled that the step transaction doctrine didn’t apply to an irrevocable trust’s ownership of life insurance policies on the life of the grantor, and the insurance policy proceeds weren’t included in the taxpayer’s estate pursuant to Maryland state law and Internal Revenue Code Sections 2031 and 2033.
Trust Acquired Two Life Insurance Policies
Dr. Larry Becker created an irrevocable trust in 2014. Later that year, the trust acquired two life insurance policies on his life. Larry never had an interest in either policy, as the trust was the initial owner and beneficiary of both policies. One policy had a death benefit of $11.47 million and required an initial premium of $999,963, and the other policy had a death benefit of $8 million and required an initial premium of $697,257.
To pay the initial premiums, the trust borrowed funds from Larry. Larry, in turn, borrowed the funds from Barry Steinfelder, the insurance broker who had assisted with procuring the policies. Barry, in turn, borrowed from an acquaintance to acquire such funds. No promissory note or other memorialization showed Larry’s loan to the trust for the payment of the initial premiums for the insurance policies. Barry paid off the loans. To memorialize the remaining debt, promissory notes were issued showing a loan owed from the trust to Barry, rather than two sets of loans, one from the trust to Larry and another from Larry to Barry (the note was issued to ALD, LLC, an entity controlled by Barry, rather than Barry individually). Under this arrangement, Larry had no right to receive any funds from the trust.
The trust entered into an agreement with LT Funding, LLC, which provided that LT Funding was obligated to pay future premiums on the policies owned by the trust, and in return, it would be entitled to: (1) 75% of the total death benefits of the policies, (2) all premiums advanced by LT Funding, and (3) interest on all premiums advanced by LT Funding at the rate of 6% per year. Under a “Subordination and Intercreditor Agreement,” LT Funding’s security interest in the policies held priority over ALD, LLC’s interest.
Larry died in 2016, and death benefits from both policies (totaling approximately $19.5 million) were paid to the trust. LT Funding, ALD, LLC and others disputed what each party was owed from that sum. The parties ultimately settled, with LT Funding being paid $9 million.
Maryland Law and Step Transaction Argument
Under Maryland law, if a person enters into a contract for insurance on the life of another without an “insurable interest” in such person’s life, the contract is deemed to constitute gambling that’s against public policy, which voids the contracting party’s interest (Md. Code Ann., Ins. Section 12-201(a) (West 2024)). As an unrelated entity to Larry, LT Funding wouldn’t have an “insurable interest” in Larry’s life and, therefore, wouldn’t be eligible to procure an insurance policy on Larry’s life for its benefit. Further, under Maryland law, if LT Funding were deemed to have impermissibly procured the insurance on Larry’s life, then Larry’s estate would hold a cause of action to recover the proceeds of such policy (See Md. Code Ann., Ins. Section 12-201(d)),
The Internal Revenue Service argued that when the described transactions collapsed under the step transaction doctrine, the policies’ death benefits weren’t at the outset primarily for the benefit of the trust’s beneficiaries but were impermissibly procured by LT Funding. It follows that if Larry’s estate would accordingly hold a cause of action to recover the proceeds of such policy pursuant to state law, but such proceeds would be includible in Larry’s estate pursuant to IRC Sections 2031 and 2033.
Court’s Holding
The court held that under the “end result” test and the “interdependence” test, the transactions at hand shouldn’t be collapsed, and the step transaction doctrine doesn’t apply. The end result test wasn’t satisfied because the parties’ subjective intent at the outset wasn’t for LT Funding to procure a death benefit on Larry’s life for its own benefit (that is, there was no prearrangement or understanding at the outset for that result). The court further held that the interdependence test wasn’t satisfied because the acquisition of the policies wasn’t dependent on the agreement with LT Funding, because the policies were fully funded for 30 months from payment of the initial premiums, and Larry and the trust had several financing options for premiums due beyond that period (including Larry’s own substantial assets of over $25 million); they used LT Funding because it was the option they determined was most financially beneficial for Larry and the trust’s beneficiaries.
