Slaying the Tax Dragon – Annuities

By: Ken Russell

Tax expertise.  It is one of the most important areas that our clients rely upon us, especially as it relates to the Pennsylvania Inheritance Tax and the Federal Estate Tax.  We, of course, provide our clients with appropriate and accepted strategies for tax minimization or avoidance.  But, in addition to “appropriate and accepted” tax strategies, our firm provides clients with “cutting edge” or “out of the box” strategies.  Courtney Zeuner, from our firm, who has a Master’s Degree in Taxation from Villanova University School of Law is able to leverage her expertise in the tax field on behalf of our clients.

As an example of such a strategy, let me review with you a cutting edge position that we recently took with the Pennsylvania Department of Revenue where we argued that an annuity (typically taxed when inherited) should be treated like a life insurance policy (not taxed when inherited) due to extraordinary facts.  This is a short excerpt from legal brief that we submitted on behalf of a client:

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An “annuity” contained in a retirement account may be exempt from Pennsylvania Inheritance Tax as life insurance under certain circumstances.

Section 2111(d) of the Inheritance and Estate Tax Act of 1991 states that all proceeds of life insurance on the life of the decedent are exempt from Pennsylvania Inheritance Tax. 72 P.S. § 9111(d).  A life insurance contract is defined as follows:

A contract possessing features of risk shifting and risk distribution, between the holder of a policy and an insurance company under which the company agrees, in return for payment of premiums, to pay a specified sum to the designated beneficiaries upon the death of the insured.

61 Pa. Code 93.131(b).

In In Re Bayer’s Estate, 26 A.2d 202 (Pa. 1942), the Pennsylvania Supreme Court compared the differences between life insurance and annuities:

If…the simple life insurance contract is contrasted with the traditional annuity contract, it will be observed that, in the case of life insurance, for annual premiums payable to the company (which in effect are annuities paid by the insured) the company will pay a specified sum at the insured’s death; whereas the converse is true of the annuity contract, for, in that transaction the annuitant pays the single sum in consideration of which the company makes annual payments to him. The amount paid on the insurance policy at the insured’s death pursuant to the obligation created in his lifetime, is a transfer of property vesting in possession or enjoyment at his death and would be subject to the inheritance tax but for the exemption in clause (d).

Id. at 314.

The Supreme Court examined a number of relevant factors in determining whether a product was life insurance or an annuity, such as whether the decedent had an intention to receive the property during his or her lifetime, the age of the decedent at the time of purchase, and whether the product delayed payment for a period of years well beyond the decedent’s life expectancy.  Id.   The Supreme Court also held that use of the word “annuity” in a contract is not dispositive of the issue.  Estate of Dwight, 134 A.2d 45 (Pa. 1957).

Under certain circumstances, it may become clear that the decedent had no intention of receiving the property during his or her lifetime.  In those cases, an “annuity” may be more akin to life insurance rather than an annuity and thus, be exempt from Pennsylvania Inheritance Tax.

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This is just one example of how our firm uses its expertise to identify and use every arrow in our quiver to slay the tax dragon.