ELITE ADVISOR BEST PRACTICES
Use of Life Insurance in Private Foundations
A powerful tool for continuing a legacy—just make sure your clients’ best intentions do not result in unintended consequences
By Peggy Hollander
- Life insurance is an efficient vehicle for creating an estate, and such contracts also may be owned by public charities.
- There are three less complex methods for providing a private foundation with the benefits of a life insurance contract.
- A private foundation may own life insurance on a public donor as well as on foundation employees and a board of directors.
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 also on foundation employees or a board of directors. There are several issues that 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. Clients should speak to their legal and/or tax advisors prior to taking any action to ensure that 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, a substantial contributor or a director of a private foundation.
First, the PLR discusses 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 for avoiding the issue of private inurement is for the foundation to hold all incidents of ownership of the life insurance policy and to 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 percent owner of the voting power of a corporation, partnership or enterprise that is itself a substantial contributor.
NOTE: A disqualified person can also include a spouse, ancestor, child, grandchild or great-grandchild of the prior named persons or a corporation, partnership, trust or estate of which the prior named persons, including family members, own more than 35 percent. A “disqualified person” is defined in IRC §4946(a)(1).
Last, there must not be a likelihood that the insured (a disqualified person) or his or her 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 he or she 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 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 in the minutes of the foundation how the insurance proceeds will be used in furtherance of the charitable purpose.
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 for providing 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 percent 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, which in turn will pay the insurance company. In some states, it may be possible for the private foundation not only to own the life insurance policy but also to pay the premiums in order to fund the foundation after the donor’s death. It is generally more beneficial for the donor to contribute the premiums to the private foundation. The donor may receive a deduction of up to 30 percent of his or her adjusted gross income for the contribution for premiums given to the private foundation, versus the 20 percent AGI maximum deduction if the donor pays the insurance company directly.
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 donors may use their charitable intentions to leave a legacy.