Legal and tax context
When a life‑insurance policy is transferred as a gift within two years of the insured's death, the valuation date is dictated by estate‑tax and income‑tax regulations. The Internal Revenue Code treats the transfer as a completed gift, so the fair market value (FMV) of the policy on the date of transfer is the amount subject to gift tax. However, for estate‑tax purposes the policy is also considered part of the decedent's estate, and the value used is the FMV on the date of death. The interplay of these rules means two dates can be relevant, but the primary valuation for the gift itself is the transfer date.
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Valuation for gift‑tax purposes
The gift‑tax valuation uses the policy's FMV on the exact day it is transferred to the recipient. FMV is determined by the cash surrender value, adjusted for any outstanding loans, and the present value of future death‑benefit payments, discounted at the applicable federal rate (AFR) for the valuation month. Insurers typically provide a quote for the surrender value; actuaries calculate the present value of the death benefit using mortality tables and the current AFR.
Valuation for estate‑tax purposes
For estate‑tax purposes, the policy is deemed owned by the decedent at death, regardless of the later gift. The estate therefore includes the FMV of the policy on the date of death. This value is used to compute the gross estate and any estate‑tax liability. If the policy is gifted within two years, the estate‑tax inclusion can trigger a "look‑through" rule, where the death‑benefit portion is still taxed to the estate even though the policy has been transferred.
Practical steps to determine the correct date
- Identify the exact date the policy was transferred to the new owner.
- Obtain a surrender‑value statement from the insurer for that date.
- Calculate the present value of the death benefit using the AFR in effect for the month of transfer.
- Confirm the date of death and obtain the policy's FMV on that date for estate‑tax reporting.
Table: Comparison of valuation dates and purposes
| Purpose | Valuation date | Key calculation |
|---|---|---|
| Gift tax | Date of transfer (within 2 years of death) | Surrender value + present value of death benefit (AFR‑discounted) |
| Estate tax | Date of decedent's death | Full FMV on death date, regardless of later gift |
Impact on the recipient
The recipient's basis in the policy is the FMV on the transfer date. If the policy is later surrendered, the basis determines any taxable gain. For income‑tax reporting, any cash‑value growth after the transfer is taxed to the recipient as ordinary income when withdrawn.
Key takeaways
• The gift‑tax valuation uses the transfer date; the estate‑tax valuation uses the death date.• Both values must be documented to satisfy IRS reporting requirements.• Accurate AFR tables and insurer statements are essential for a defensible valuation.