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The Goodman Triangle

I regularly get asked about the “Insurance Triangle”, what it is and how it plays into things.  This is a reference to the “Goodman Triangle” Goodman V. Commissioner, 156 F.2d 218

In this case Mrs. Goodman transferred five existing policies insuring her husband’s life to a Revocable life insurance trust.  Beneficiaries of the trust were her three children and her sister-in-law.  About a decade later her husband died and the trust became irrevocable.

It was determined that at the time that the trusts became irrevocable, Mrs. Goodman made a gift to the trust beneficiaries.  The value of the gift was the value of the trust, including the death benefit on the life insurance policies.

Though few life insurance policies are held in revocable trusts, the Goodman case remains one of the most important cases for estate planning advisors.  Unfortunately, it is a problem caused by a lack of understanding of tax law and a failure to do proper planning.  The Goodman Triangle result is most often seen in situations where a trust is not used. In theory, making someone other than the insured the owner could prevent the policy from being included in the insured’s estate, however, when the policy owner is not the insured and not the only beneficiary, it is likely that gift taxes will apply.

Most commonly this is an issue when one spouse owns a policy on another spouse and names the children the beneficiary or when one child owns a policy on a parent(s) and other siblings are also named beneficiaries.

The Service has ruled that when one party owns a policy on the life of a second party and names a third party as the beneficiary, on the death of the insured the policy owner makes a completed gift to the beneficiary of the death benefit proceeds.  This judgment is based on the difference between complete and incomplete gift which in turn is based on the donor retaining ownership rights in the contract.

A common “Goodman Triangle” situation is demonstrated by the following example.

Mom and Dad want to insure their lives for $3,000,000 to create a source of liquid assets that will allow the family to pay estate taxes after their deaths.  However, they decide that they don’t want to go through the hassle and expense of creating an irrevocable trust to own the policy.  The children are already in their forties and responsible adults so the parent’s do not care much about the management benefits of a trust either.  However, two of the kids live overseas and it is much simpler to have the child who lives locally own the policy while all three are named equal beneficiaries.  Upon the surviving parent’s death, each child receives a $1,000,000 death benefit, but to the surprise of the local child who owns the policy, it is deemed that he has made a taxable gift of $2,000,000 to his siblings when the death benefit is paid.

The Goodman Triangle can cause unexpected gift tax liability in any situation where a life insurance policy is owned by one person on another’s life and names a third person (who is not the owner’s spouse) as the policy beneficiary.

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