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While the concept of using an unfunded life insurance trust(1) as a vehicle to receive death proceeds is common in the United States for U.S. persons, it is a relatively unused planning tool for the non-resident alien (NRA).(2) Clearly, there can be similar benefits for the NRA in considering the advantages of a well-designed insurance program linked to the estate planning benefits of a trust. Furthermore, the Internal Revenue Code (IRC) generally treats NRAs, although technical planning may be required to accomplish the results, more favorably than it does U.S. persons. This is certainly true in respect to insurance proceeds.(3) Unlike the U.S. person who will find life insurance proceeds on a policy owned by him taxable as part of his gross estate (if he retains control or has "incidents of ownership" over the policy), such proceeds are specifically exempt from federal taxation in the estate of an NRA.(4) This not only enhances the ultimate financial value of a policy, but permits more flexibility in the design and administration of a life insurance trust. The fiduciary planning involved, however, often takes a form quite different from that typically used for a U.S. insured person.
Prior to the Tax Reform Act of 1976,(5) typical life insurance trust planning for a U.S. person included the creation of a revocable trust named as beneficiary of the policy proceeds. The trust would split into two sub-trusts at his death: Trust A would be worded to qualify for the then maximum amount of the marital deduction(6) (which would not be taxable to his estate), and Trust B (which would not qualify for tax exemption) would be structured so that it would not be taxed at the death of the surviving spouse. In addition to the trust being fully revocable and amendable, the grantor/insured would continue to pay premiums on the policies and would continue to retain "all incidents of ownership" over the policies. This would include the right to change the beneficiaries: for example designating one or more individuals to receive the proceeds directly rather than through the insurance trust, or by changing the beneficiaries of the non-qualifying sub-trust. After 1976, and the introduction of the unlimited marital deduction concept, more complex planning techniques came into play to eliminate...