Estate of Knipp, 25 T.C. 138 (1955)

The tax court addressed whether a deceased partner’s share of partnership income was includible in the value of his gross estate, given the partnership agreement’s provisions for profit distribution upon death, and whether life insurance proceeds were includible in the gross estate based on the decedent’s indirect payment of premiums and incidents of ownership.

Summary

The Estate of Knipp case concerned the estate tax treatment of a deceased partner’s income and life insurance proceeds. The Tax Court held that the decedent’s share of partnership income was not includible in his gross estate because the partnership agreement dictated a fixed payment upon death, effectively ending his income interest at that point. Regarding the life insurance, the court determined that the proceeds from policies assigned to the partnership were not includible because the premiums were paid by the partnership, and the decedent did not possess any incidents of ownership. However, the proceeds from a policy where the decedent retained the right to change the beneficiary were includible. The court’s decision underscored the importance of partnership agreements and the specific rights and control over insurance policies in determining estate tax liability.

Facts

Frank Knipp and Howard Knipp were partners in a business. The partnership’s taxable year ended on January 31st. The partnership agreement stipulated a ‘salary’ of $25,000 per year to each partner, payable monthly, although for tax purposes this was considered a share of profits. The agreement provided that upon a partner’s death, the estate would receive the partner’s credit balance at the beginning of the year, less any withdrawals. Frank Knipp died on November 21, 1947. The partnership was the beneficiary of 11 life insurance policies on Frank’s life. All policies were assigned to the partnership except for one policy from Sun Life Assurance Company of Canada. The IRS included in the estate tax, Frank’s share of the net income of the business and the life insurance proceeds.

Procedural History

The Commissioner of Internal Revenue determined deficiencies in the estate tax, including (1) the value of Frank’s share of the partnership’s earnings to the date of his death and (2) the proceeds of life insurance policies in the gross estate. The petitioners contested the deficiencies in the Tax Court.

Issue(s)

1. Whether the partnership’s taxable year ended on the date of Frank Knipp’s death for the purpose of including partnership income in his estate.

2. Whether the value of Frank Knipp’s share of the partnership’s income was includible in his gross estate.

3. Whether the proceeds of the 11 life insurance policies were includible in the gross estate because Frank paid the premiums or possessed incidents of ownership.

4. Whether the proceeds of the Sun Life insurance policy were includible in the gross estate because Frank possessed incidents of ownership.

Holding

1. Yes, because the partnership agreement effectively fixed and limited Frank’s income interest upon his death.

2. No, because the value of the deceased partner’s share of the partnership’s income was not includible in his gross estate.

3. No, because the premiums were paid by the partnership, and Frank did not possess incidents of ownership.

4. Yes, because Frank retained the right to change the beneficiary.

Court’s Reasoning

The court examined the partnership agreement and determined that the agreement terminated Frank’s income interest at the date of his death by fixing his distributive share. The agreement’s terms, including the ‘salary’ provision, and the settlement terms upon death, meant that Frank had no further claim to partnership earnings beyond that date. The court distinguished this case from those where the estate continued to share in profits after a partner’s death.

Regarding the life insurance, the court applied the principle established in *Estate of George Herbert Atkins, 2 T.C. 332 (1943)*. The court held that the premiums were paid by the partnership, not the decedent. It reasoned that the partnership held all legal incidents of ownership. Since the decedent did not pay the premiums directly or indirectly and lacked control over the policies as an individual, the proceeds were not includible under §811(g) of the 1939 Internal Revenue Code.

For the Sun Life policy, the court found that Frank had retained the right to change the beneficiary. The court reasoned that this right was an incident of ownership that required the inclusion of the policy’s proceeds in the gross estate, as prescribed by §811(g).

Practical Implications

This case highlights that the precise language of a partnership agreement controls the estate tax treatment of partnership income, especially upon a partner’s death. Attorneys should meticulously draft partnership agreements to clearly define the interests and rights of partners, including the treatment of income and assets upon death. Clear and explicit language in insurance policy assignments is crucial to determine whether the decedent retained incidents of ownership. When a partnership owns life insurance policies on partners, the payment of premiums by the partnership and a lack of incidents of ownership in the individual partners will prevent inclusion of the proceeds in the individual’s estate. This is particularly relevant where a partner retains the ability to change beneficiaries.

The case emphasizes the critical need for attorneys to carefully review partnership agreements and insurance policies when planning an estate to accurately assess and minimize potential estate tax liabilities.