Life Ins Proceeds to Estate

[Randall]

Just to confirm, life insurance proceeds paid to an estate are not subject to estate income tax.  No 1099-R.  Not reported as income on 1041.  Correct?

 

[WITAXLADY]

met with an attorney yesterday - that is my understanding...

D

[Sara EA]

Life insurance proceeds are not income so are not reported on a 1041 (there may be some interest included, which is income).  However, life insurance is taxable on a 706, which taxes assets instead of income.  With the high estate tax threshold it's unlikely any of our clients will ever file a federal 706, but some states have lower exemptions. 

[WITAXLADY]

? That I do not understand?

[Randall]

10 hours ago, Sara EA said:

Life insurance proceeds are not income so are not reported on a 1041 (there may be some interest included, which is income).  However, life insurance is taxable on a 706, which taxes assets instead of income.  With the high estate tax threshold it's unlikely any of our clients will ever file a federal 706, but some states have lower exemptions. 

That's my understanding too.  Thanks.

[Randall]

9 hours ago, WITAXLADY said:

? That I do not understand?

I'm not sure what you're asking.

 

[WITAXLADY]

However, life insurance is taxable on a 706, which taxes assets instead of income.  With the high estate tax threshold it's unlikely any of our clients will ever file a federal 706, ???

[Lion EA]

But, might file a federal 706 for "portability." So, we do need to know what should be reported on a 706 and what does not have to be reported on a 706. Good topic.

[jklcpa]

19 minutes ago, WITAXLADY said:

However, life insurance is taxable on a 706, which taxes assets instead of income.  With the high estate tax threshold it's unlikely any of our clients will ever file a federal 706, ???

What Sara is saying is that the estate threshold is high at $11.58 million before the estate itself becomes taxable, so for most people there may be no need to file Form 706 even with the value of the life insurance included.  

[WITAXLADY]

thx - just do not understand why life ins is taxable?

[Max W]

22 minutes ago, WITAXLADY said:

thx - just do not understand why life ins is taxable?

It isn't if the beneficiary is an individual, instead of a trust, or estate.   There could be taxable interest, though, if there is sufficient time elapsed from DOD to the date of distribution.

[Randall]

10 hours ago, Max W said:

It isn't if the beneficiary is an individual, instead of a trust, or estate.   There could be taxable interest, though, if there is sufficient time elapsed from DOD to the date of distribution.

Are you saying if the beneficiary is an estate, the proceeds are taxable on 1041?

[DANRVAN]

16 hours ago, WITAXLADY said:

thx - just do not understand why life ins is taxable?

In some situations life insurance proceeds are considered part of a decedent's estate and taxed for inheritance tax, but not for income taxes.

[Max W]

On 2/24/2020 at 3:00 AM, Randall said:

Are you saying if the beneficiary is an estate, the proceeds are taxable on 1041?

Yes.  The L. I. becomes an asset of the trust/estate and thus is taxable at those rates.  One of the first rules of Retirement Planners is to tell their clients to NOT make their trust a beneficiary.

"One poor decision that investors seem to frequently make is the naming of "payable to my estate" as the beneficiary of a contractual agreement, such as an IRA account, an annuity, or a life insurance policy. However, when you name the estate as your beneficiary, you take away the contractual advantage of naming a real person and subject the financial product to the probate process. Leaving items to your estate also increases the estate's value, and it could subject your heirs to exceptionally high estate taxes."

https://www.investopedia.com/articles/pf/06/transferlifeinsurance.asp

There is an exception and that is for a Irrevocable Life insurance trust (LIT).

https://finance.zacks.com/trust-life-insurance-better-income-taxes-10789.html

[Randall]

17 minutes ago, Max W said:

Yes.  The L. I. becomes an asset of the trust/estate and thus is taxable at those rates.  One of the first rules of Retirement Planners is to tell their clients to NOT make their trust a beneficiary.

"One poor decision that investors seem to frequently make is the naming of "payable to my estate" as the beneficiary of a contractual agreement, such as an IRA account, an annuity, or a life insurance policy. However, when you name the estate as your beneficiary, you take away the contractual advantage of naming a real person and subject the financial product to the probate process. Leaving items to your estate also increases the estate's value, and it could subject your heirs to exceptionally high estate taxes."

https://www.investopedia.com/articles/pf/06/transferlifeinsurance.asp

There is an exception and that is for a Irrevocable Life insurance trust (LIT).

https://finance.zacks.com/trust-life-insurance-better-income-taxes-10789.html

Max, my question has to do with income tax, not estate tax.  Yes, it's an asset included in the estate.  But are the proceeds of a life insurance policy considered income to the estate and subject to the estate income tax (Form 1041).  I know IRA and other retirement income is subject to the income tax on the estate but I'm wondering about life insurance proceeds.

[Max W]

 

1 hour ago, Randall said:

Max, my question has to do with income tax, not estate tax.  Yes, it's an asset included in the estate.  But are the proceeds of a life insurance policy considered income to the estate and subject to the estate income tax (Form 1041).  I know IRA and other retirement income is subject to the income tax on the estate but I'm wondering about life insurance proceeds.

As far as I know, it would be reported Other Other portfolio income on Line 5 K-1. (page 21 of 1041 instructions).  Any distriubtion would be an expense to the estate.  There might be states that have different rules.

[Roberts]

Other than some odd timing issue, an estate / trust really shouldn't be the beneficiary of life insurance. For the people who are trying to avoid estate taxes, hopefully they'd be smart enough to know not to do this. The reason they likely own life insurance was to bring the value of their estate down low enough to avoid the estate tax with a paid up life insurance policy paid to their heirs.

[Roberts]

Line 8 of the 1041 "other income" specifically says : 

 

Note. “ELA” and its dollar amount are the first entry to make on line 8.•Unpaid compensation received by the decedent's estate that is IRD.•Any part of a total distribution shown on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., that is treated as ordinary income.

[Randall]

I'm still not convinced life insurance policy death proceeds would be taxable (not talking about the 706 assets).  Yes on retirement account, annuities, even some other life insurance contracts.  But if the beneficiary is an individual, the death payout would not be taxable.  If you put the amount on the 1041, deducted it as a distribution to the estate beneficiaries, it would have to flow thru on their K-1 schedules as ordinary income.  I don't think this should be treated as ordinary income.  Anyone have any references specifically to death proceeds of a life insurance policy paid to an estate.

Yes I think we all agree you should not name the estate as beneficiary.  But people do these things and we learn about it afterward and have to sort it out.

[DANRVAN]

not taxable to the estate, 

Reg § 1.101-1.

[Randall]

2 hours ago, DANRVAN said:

not taxable to the estate, 

Reg § 1.101-1.

Thanks.

 

 

[Burke]

Life insurance DEATH PROCEEDS are not taxable to an estate on Form 1041 (which calculates income tax) except for certain interest earned from date of death to the date benefits are paid.  A form 1099-INT will be issued for that.   As others have said, it is an entry on Form 706 but we probably don't have any clients now which exceed the threshold.  (In the olden days, yes, it came into play when the threshold was $650K.)    Perhaps Max was thinking about the proceeds of a policy which is CASH SURRENDERED, and it exceeded basis.  For that situation, a 1099-R would be issued for the taxable income portion and it would be reported on Line 8, Other Income.  This might be a situation that could occur in certain trusts where the trustee cashed in the policy.   You have to differentiate between the two types of payouts.