Opinion
Docket No. 21659-86.
1989-08-7
ESTATE OF EDDIE L. HEADRICK, DECEASED, CLEVELAND BANK & TRUST COMPANY AND CHARLES L. ALMOND, EXECUTORS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Robert L. McMurray, for the petitioners. Edsel Ford Holman, Jr., for the respondent.
D, a decedent, established an irrevocable intervivos trust with B, a bank, as trustee. The trust agreement drafted by D authorized, but did not require, B to invest the trust principal in life insurance policies. B exercised independent discretion in acquiring a whole life insurance policy on D's life. D contributed cash annually to the trust in amounts sufficient to meet the trust's cumulative monthly premium obligations. D died in an automobile accident within three years of the trust's purchase of the policy. HELD, D never possessed ‘incidents of ownership‘ in the life insurance policy within the meaning of I.R.C. section 2042.
HELD FURTHER, because D never possessed under section 2042 any incidents of ownership in the policy on his life, the proceeds therefrom are not includable in his gross estate under I.R.C. sections 2035(d)(2) and 2035(a). Estate of Leder v. Commissioner, 89 T.C. 235 (1987), on appeal (10th Cir., Jan. 11, 1988), followed. Robert L. McMurray, for the petitioners. Edsel Ford Holman, Jr., for the respondent.
NIMS, CHIEF JUDGE:
Respondent determined a deficiency in petitioners' Federal estate tax liability of $192,881.15. The issue for decision is whether the proceeds of a life insurance policy purchased within three years of the decedent's death by a trust established by the decedent are properly includable in the decedent's gross estate under section 2035(a). (All section references are to sections of the Internal Revenue Code or the Estate Tax Regulations, as the case may be, in effect at decedent's death. All Rule references are to the Tax Court Rules of Practice and Procedure.) Resolution of this issue requires us to determine whether the decedent directly or indirectly possessed incidents of ownership over the life insurance policy during his lifetime. Sections 2035(d)(2), 2042, and 2035(a).
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference.
Petitioners, Cleveland Bank and Trust Company (CBT or the bank) and Charles L. Almond, at all relevant times have been the duly qualified and acting co-executors of the estate of Eddie L. Headrick (decedent) under Letters Testamentary granted on June 22, 1982, by the Chancery Court of Bradley County, Tennessee.
Decedent, whose estate is the subject of this dispute, received his law degree from the University of Tennessee and his masters degree in tax law from New York University. Thereafter, he worked as a tax attorney in Cleveland, Tennessee. As part of his personal estate planning, the decedent, then 30 years of age, skillfully drafted an irrevocable trust agreement (Trust Agreement) of which decedent was grantor. The Trust Agreement designated decedent's wife and children as primary beneficiaries, conferred on the trustee by reference to Tennessee statutes most of the fiduciary powers recognized in that state, specifically permitted the trustee to accept additional contributions of property, reserved to decedent the right to remove any trustee at will and appoint a successor bank trustee, granted trust beneficiaries a limited power to withdraw trust property within 30 days of the contribution of such property and authorized the trustee to hold life insurance policies as trust principal. Regarding the power of the trustee to hold life insurance as a trust investment, the Trust Agreement specifically provided:
2.3 LIFE INSURANCE AS TRUST PRINCIPAL: The trustee may accept the contribution of a life insurance policy on my life or on a beneficiary or on a person in whom I or a beneficiary have an insurable interest as Trust Principal. Likewise, the trustee may purchase insurance on my life, or on a beneficiary or on a person in whom there is an insurable interest, and hold each such policy as Trust Principal.
2.4 PAYMENT OF PREMIUMS: The trustee may pay the premium on each policy of insurance held as Trust Principal from either Trust Principal or income, and such payment is an authorized expenditure. However, if the trustee does not have sufficient funds with which to pay a premium, it may:
(i) borrow money to pay the premium;
(ii) use such part of the cash surrender value of a policy (including a policy other than the one on which the premium is due) as is necessary to pay the premium; or
(iii) refuse to pay the premium and either convert the policy to a paid up policy or retain full coverage for an extended definite term or, if term insurance, permit the policy to lapse.
The decision of the trustee on which course of action to take is binding upon each beneficiary.
2.5 OWNERSHIP OF INSURANCE: The trustee must own each policy of insurance purchased by, or contributed to, it. The trustee alone shall exercise each incident of ownership over each such policy.
Prior to executing the Trust Agreement, decedent met with life insurance agent William Turner to price life insurance policies. One of the policies discussed was offered by Massachusetts Mutual Life Insurance Company.
Decedent desired CBT to act as trustee of an intervivos trust to be established in accordance with the terms of the Trust Agreement. On December 18, 1979, decedent went to CBT to discuss establishing a trust. At the time of the meeting, CBT was ‘between trust officers.‘ Decedent met with James C. Brewer (Brewer), the president of CBT, who up to that time had had no experience in the trust and estates field and was unfamiliar with the procedures of opening trusts. Decedent and Brewer generally discussed the trust for about 30 minutes. From the discussion, Brewer believed decedent intended the trust to function as an ‘insurance trust for [decedent's] family.‘ The decedent did not, however, condition the establishment of the trust on CBT's commitment to acquire life insurance with the funds contributed to corpus. During the meeting the Irrevocable Trust Agreement of Eddie L. Headrick was executed by decedent as trustor and CBT as trustee. Brewer signed the Trust Agreement on behalf of CBT with the intention that the bank be bound by the terms of the executed Trust Agreement. CBT's trust department retained the executed Trust Agreement.
Schedule A of the executed Trust Agreement indicated that decedent irrevocably assigned $5,900 to CBT contemporaneously with the execution of trust. On December 18, 1979, the date the trust was established, Lucille Bonderud Headrick, wife of decedent, executed on behalf of herself and her minor children a fully informed waiver of the beneficiaries' right to withdraw any portion of her husband's $5,900 contribution to trust principal.
On December 19, 1979, CBT deposited decedent's $5,900 contribution in account No. 14738-411, a savings account opened in the name of Cleveland Bank and Trust Company, Trustee for the irrevocable trust of the beneficiaries under the trust of Eddie L. Headrick.
On December 19, 1979, Brewer, president of trustee CBT, executed Part I of Massachusetts Mutual Life Insurance Company Application No. 160029 (application) for the purpose of obtaining a $375,000 insurance policy on the life of the decedent. The application stated that the policy owner would be Cleveland Bank & Trust Co. of Cleveland, Tenn., Trustee u/a Eddie Lynn Headrick dated December 18, 1979, their successors in trust or assigns. Similarly, the application designated Cleveland Bank & Trust Co. of Cleveland, Tenn., Trustee u/a Eddie Lynn Headrick dated December 18, 1979, their successors in trust or assigns as beneficiary. Decedent signed Part I of the application as the insured.
CBT elected on the application to remit policy premiums by bank draft on a monthly basis. The application stated that ‘the first premium on the insurance now applied for [had] been paid in exchange for a fully completed Conditional Receipt.‘ This first premium payment in the amount of $435.76 was remitted by a check made payable to the order of Massachusetts Mutual Life, dated December 20, 1979, and drawn on account No. 012-43180-7-05 by CBT Trustee for Eddie Headrick. The check was signed by Beth C. Woodard, ATO, CBT's acting trust officer. Checking account No. 012-43180-7-05 was opened in the name of CBT Co., Trustee for the irrevocable trust of the beneficiaries under the trust of Eddie L. Headrick on December 18, 1979.
On December 20, 1979, the day after CBT executed part I of the application, decedent submitted to the medical examination required in Part 2 of the application, an examination performed by Marvin R. Batchelor, M.D.
CBT's application for insurance on the life of decedent was approved. On January 8, 1980, Massachusetts Mutual Life Insurance Company issued policy number 6-154-721 (policy), a $375,000 convertible whole life policy, to Cleveland Bank & Trust Company, as trustee, or the then acting trustee under the trust agreement dated December 18, 1979. Beginning on December 20, 1979, and continuing until decedent's death, CBT transferred $435.76 each month from the trust's savings account to the trust's checking account, and as trustee paid Massachusetts Mutual Life the required monthly premiums. On December 30, 1980, decedent made a second contribution to the trust corpus of $5,500. On December 22, 1981, decedent made a third and final contribution of $2,000. No beneficiary elected to withdraw any portion of decedent's second or third contributions. The total contributions of $13,400 covered all premium payments made by the trust.
Part 3 of the policy issued to CBT described the rights of the owner as follows:
While the Insured is living, the Owner may exercise all rights given by this policy or allowed by us. These rights include assigning this policy, changing Beneficiaries, changing ownership, enjoying all policy benefits and exercising all policy options. No ownership rights were conferred by the policy on the decedent. Likewise, no ownership rights in the policy were indirectly acquired by the decedent via a reserved power in the Trust Agreement. On the contrary, as discussed above, the agreement articulated that ‘the trustee alone shall exercise each incident of ownership over each [life insurance] policy.‘
Approximately three months after the trust was established, decedent joined CBT's board of directors and as a director became a member and chairman of CBT's trust committee. One of the trust committee's responsibilities was to review and discuss new trust accounts and the investments in those trusts. The Trust Agreement was first reviewed by the bank's trust committee on April 30, 1980. Thereafter, the trust was reviewed every three or four months as part of the bank's routine trust administration procedure. CBT's trust department was regularly audited by the FDIC and Tennessee bank auditors. Neither the trust committee nor the bank auditors determined that CBT improperly administered the trust in question.
The decedent, age 33, tragically died in an automobile accident on June 19, 1982, a date which was within three years of the trust's purchase of the life insurance policy. Decedent was survived by his wife and three minor daughters.
Upon decedent's death, Massachusetts Mutual Life Insurance Company paid $378,701.93 in death benefits to the trustee as owner of the policy. The life insurance proceeds were not included in decedent's gross estate on the estate tax return filed by the executors of his estate. Respondent determined in the statutory notice of deficiency that:
The proceeds of Massachusetts Mutual Life Insurance Company policy No. 6-154-721, transferred to Cleveland Bank & Trust Company as trustee, constitute a transfer within the meaning of section 2035(a) of the Internal Revenue Code, and is therefore includable in the decedent's taxable estate. Since no amount was included on the estate tax return, the taxable estate is increased $378,701.93.