Today marks the 75th anniversary of the March 3, 1941, Opinion of the U.S. Supreme Court in Helvering v. Le Gierse, 312 U.S. 531, 61 S. Ct. 646, 85 L. Ed. 996 (1941), which continues to even now define the term "insurance" for federal tax purposes.
In 1936, Mrs. Le Gierse passed away at the age of 80. But the month before her death, she entered into two contracts with Connecticut General Life Insurance Company.
For the first contract, Mrs. Le Gierse paid $4,179 for a lifetime annuity that was to pay her $589.80 every month until she passed.
For the second contract, Mrs. Le Gierse paid $22,946 to purchase a $25,000 life insurance policy that would pay to her daughter when Mrs. Le Gierse passed.
Curiously, Connecticut General did not require Mrs. Le Gierse to take the routine physical examination that most folks have when they purchase life insurance. The real truth was that everybody involved was treating the two contracts as a single transaction, even though in isolation each appeared to be independent. But the bottom line is that the Connecticut General would not have issued the annuity to Mrs. Le Gierse unless she also bought the life insurance policy, and vice versa.
So why go through these machinations? To avoid paying federal estate taxes, of course. When Mrs. Le Gierse passed, the life insurance policy paid $25,000 directly to her daughter, and thus kept the money out of the late Mrs. Le Gierse's taxable estate. A federal estate tax return was filed that did not reflect the $25,000.
The IRS was not impressed, and assessed a deficiency. The IRS lost before the Board of Tax Appeals, but then won before the U.S. Second Circuit Court of Appeals.
The late Mrs. Le Gierse daughter then filed an appeal to the U.S. Supreme Court, which decided to hear the case because of a split between the circuit courts about the meaning of "insurance" in this context, and whether such proceeds were includable in the late Mrs. Le Geirse's gross estate.
Under the Internal Revenue Code of the time, the decedent's "gross estate" comprised pretty much everything that she owned on her death, but not a life insurance payment unless it exceeded $40,000.
The term "insurance" was not defined in the Code (then or now), however, and the legislative history of the Code was not helpful in defining the term either. Thus, the Court decided to give its own definition of "insurance" -- and the next sentence would define "insurance" for at least the next 75 years:
Historically and commonly insurance involves risk-shifting and risk-distributing.
So, there you have it: Insurance has two elements: (1) risk-shifting, and (2) risk-distributing. "Risk-shifting" means that the risk of loss has moved from one party to another. "Risk-distributing" means that the insurer party, i.e., the party accepting the risk, is spreading the particular accepted risk among many similar risks to mitigate the possibility of losing money on all the policies in the aggregate.
But the Court did not find that the elements of "insurance" had not been met. Applying substance over form, the Court decided that there was really just one contract here, not two, and all the parties had admitted as much. And the one contract did not provide for insurance, because the annuity offset the life policy, and vice versa:
Considered together, the contracts wholly fail to spell out any element of insurance risk. It is true that the ‘insurance’ contract looks like an insurance policy, contains all the usual provisions of one, and could have been assigned or surrendered without the annuity. Certainly the mere presence of the customary provisions does not create risk, and the fact that the policy could have been assigned is immaterial since no matter who held the policy and the annuity, the two contracts, relating to the life of the one to whom they were originally issued, still counteracted each other. It may well be true that if enough people of decedent's age wanted such a policy it would be issued without the annuity, or that if the instant policy had been surrendered a risk would have arisen. In either event the essential relation between the two parties would be different from what it is here. The fact remains that annuity and insurance are opposites; in this combination the one neutralizes the risk customarily inherent in the other. From the company's viewpoint, insurance looks to longevity, annuity to transiency. * * *
Here the total consideration was prepaid and exceeded the face value of the ‘insurance’ policy. The excess financed loading and other incidental charges. Any risk that the prepayment would earn less than the amount paid to respondent as an annuity was an investment risk similar to the risk assumed by a bank; it was not an insurance risk as explained above.
Because the two contracts taken together did not either shift nor distribute the risk, they failed to provide "insurance", and the IRS collected the tax on the $20,000 from the Estate of the late Mrs. Le Gierse.
And left us with this relatively simple, yet practically workable, definition of "insurance".
This article at http://onforb.es/21LBilR
