289 / Is there a loss of the income tax exemption for death proceeds following a transfer of life insurance policies between partners or to a partnership in which the insured is a partner?

No.

The transfer for value rule does not apply where a policy is transferred to a partner of the insured or to a partnership in which the insured is a partner.¹ The partnership actually must operate as a partnership, however, and not exist in form only.² A partner can sell a policy on the partner’s life to the partnership or to another partner. A retiring partner can sell to an incoming partner the policy the partner owns on another partner’s life. A partnership can sell a policy to an insured partner or to a copartner of the insured. Where a partnership owns a key person policy on the life of a non-partner, there is no transfer for value when a new partner enters or an existing partner leaves the partnership, provided the partnership is not terminated by that action.³

Sale of a policy to a member of an insured’s family who is not a partner would disqualify the proceeds for exemption. Where there is an insurance-funded buy-sell agreement between more than two partners and a partner dies, a surviving partner may buy policies on the lives of other surviving partners from the deceased’s estate without loss of tax exemption for the death proceeds.⁴

The IRS has ruled in a private letter ruling that members of a limited liability company (“LLC”), which was classified as a partnership for federal tax purposes, would be considered partners for purposes of the transfer for value rule.⁵

A transfer for value by a corporation to a partnership in which an insured shareholder is a partner comes within the exception.⁶ Similarly, a transfer to shareholders who are partners, even though in an unrelated partnership, falls within the exception.⁷ Further, the IRS has ruled privately that a transfer of policies insuring shareholders/partners from a corporation to a partnership established specifically to receive and manage the policies comes within the exception.⁸

A sale of policies by an insured’s grantor trust to a limited partnership where the insured was a limited partner was ruled to fall within the exemption.⁹

The IRS has indicated, however, that it will not issue rulings concerning whether or not the exception applies to a transfer of a life insurance policy to an unincorporated organization where substantially all of the organization’s assets consist or will consist of life insurance policies on the lives of its members.¹⁰

If a policy is transferred more than once and the last transfer, or the last transfer for value, is to a partner of the insured or to a partnership in which the insured is a partner, proceeds will be entirely tax-exempt regardless of any previous transfer for value.¹¹