Cahill: Facts, Takeaways and Thoughts

By Richard L. Harris, CLU ® AEP ®

For those of you that don’t follow intergenerational split-dollar arrangements here’s a quick and dirty about how they normally work.

  • Three generations involved
  • Senior is wealthy and older, often in 80’s or 90’s
  • Senior makes an advance or a loan to an ILIT for the benefit of
    grandchildren.
  • In the case of an advance (an economic benefit arrangement as in
    Cahill) the receivable is the greater of the cash surrender value or the
    premiums paid.
  • Insured is child(ren) of senior.
  • Repayment not made until death of child/insured.
  • Senior dies.
  • Receivable is in senior’s estate.
  • What is the value of a receivable not due until a long indeterminate
    time in the future that pays little of nothing until the death of the
    individual?
  • Model for valuation– Life settlement market

The transaction facts
The Cahill’s wanted it all.

  • Senior was incompetent and son as trustee of senior’s revocable trust took all actions.
  • Senior died 15 months after the transaction.
  • The son and his wife, separately, were the insureds.
  • The son was a beneficiary of the ILIT along with his children.
  • The son and the ILIT trustee – his cousin and business partner – could
    terminate the arrangement at any time by common agreement.
  • The advance was facilitated by a $10,000,000 loan from an outside lender, repayable in five years.
  • The lender took a security interest in the policy as collateral for the
    loan.
  • The revocable trust and the trustee (the son) were the parties to repay
    the note.
  • The life insurance policy had a cash surrender value at senior’s death
    of $9,600,000.
  • The estate valued the note at less than $200,000 (which while seemingly not, is reasonably justified by the methodology used in valuation).

Surprise – the IRS did not like it! They valued the receivable at the cash surrender value of $9,600,000. There were other unrelated interfamily loans that the estate valued at $8,000,000 and the IRS valued those at $12,000,000. The IRS asked for estate taxes based on their valuations plus a 20% undervaluation penalty.

Issues before the court¹
There are three IRS code sections that have a potential impact on the
valuation of the receivable, §§2036, 2038 and 2703(a). All of them originally related to valuation of business interests and in one way or another disregarded restrictions that in the Cahill case would have resulted in inclusion at full value in the estate. As a preemptive move Cahill petitioned for partial summary judgement saying that as a matter of law, those sections did not apply to the transaction. The court ruled against them.

The court decided that based on the facts that those sections did apply.² In the decision the judge pointed out certain things.

  • §1.61-22, the split-dollar regulation that governs the transaction, is an
    income and gift tax regulation and does not apply to estate taxes.³
  • The judge said that the petitioner’s analogy of the receivable and a note was not valid. In the Memo he wrote, “A note is generally a bargained-for agreement between two parties in which one party lends a sum of money and the other party agrees to repay that sum with interest over time.”

Takeaways

  • The case was settled.
  • A settlement does not create a precedent.
  • There appears to have been some give and take between the parties.
    • The estate conceded the valuation of the split-dollar receivable at $9,600,000 and is going to pay the estate tax plus a 20% penalty.
    • The IRS conceded the $8,000,000 valuation of the interfamily loans. This saved the estate approximately $2,400,000 in taxes and penalties.
  • The settlement was published. The IRS was able to broadcast a warning.

Thoughts
There are other points to be made.

  • One can do a loan split-dollar arrangement under §1.7872-15.
  • Under §1.7872-15 there are several benefits:
    • Loan treatment by the IRS can be guaranteed. 
    • The loan can be repayable at the death of the insured.
    • The loan can be secured by just the death benefit of the policy.
  • Cahill would have been better off not doing the transaction.
    • Even if they lost on the other valuation issue it would have cost
      $2,400,000.
    • Instead it cost $4,600,000.
    • They still owed $10,000,000 plus interest to the lender, with only $9,600,000 in cash value available to pay it – an additional loss of $400,000 plus interest.

As has been pointed out in other articles (see endnote i), a split-dollar loan arrangement, especially using the benefits in §1.7872-15 listed above, may have a chance of achieving a better result than Cahill. To date there have not been any reported court cases regarding loan split-dollar.


¹There are a number of informative articles about this case:
“Estate of Cahill v. Commissioner” Akers, Bessemer Trust white paper, June 28, 2018, NAEPC Journal of Estate Tax & Planning, Issue 29, July 2018
“Intergenerational Split-Dollar Life Insurance Arrangements Take a Hit in Estate of Cahill” Zaritsky and Borselli, July 12, 2018
“Intergenerational Split Dollar – Recent Adverse Decisions in Morrissette and Cahill, Where Do We Go from Here?” Slavutin, Shenkman and Harris, Steve Leimberg’s Estate Planning Newsletter #2651, July 17, 2018
“Intergenerational Split Dollar – Cahill Case Settled – Taxpayer Concedes Split Dollar Valuation Issue” Slavutin, Shenkman and Harris, Steve Leimberg's Estate Planning Newsletter #2663, Sept. 13, 2018
“Cahill, Powell and the Ongoing Evolution of IRC Section 2036(a)(2), Angkatavanich and Ransome, Trusts & Estates September 2018

²Cahill v. Commissioner, T.C. Memo. 2018-84 (June 18, 2018)

³What if the receivable became part of a gift transaction?

§1.7872-15 (d)

§1.7872-15(e)(5)(ii)

§1.7872-15(a)(2)(i)(C)

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