IRC 2206: Liability for Estate Tax on Life Insurance

When an individual with a sizable estate passes away, their assets may be subject to federal estate tax. This tax is calculated on the decedent’s gross estate, which includes all property they owned or had an interest in at death. The gross estate is comprehensive and often includes assets that do not pass through probate, such as retirement accounts, property in a living trust, and life insurance policies.

Life insurance proceeds are paid directly to a named beneficiary and are not part of the probate estate. However, these funds are typically included in the decedent’s gross estate for tax purposes under Internal Revenue Code (IRC) Section 2042. This inclusion can increase the total estate tax due, which raises the question of who is responsible for paying the associated tax on those proceeds.

The Executor’s Right to Recover Estate Tax

Federal law provides a specific answer under Internal Revenue Code (IRC) Section 2206. This rule gives the executor of an estate the right to recover a proportionate share of the federal estate tax from the beneficiary of a life insurance policy. This is a right of reimbursement for the estate, not a tax levied directly on the beneficiary.

The estate is legally obligated to pay the entire tax bill first, as determined on Form 706, the United States Estate Tax Return. This right of recovery exists automatically under federal statute. After the executor pays the full tax amount to the IRS, they can then legally pursue the life insurance beneficiary for their share of the tax burden.

This provision applies when life insurance proceeds are included in the gross estate and are receivable by a beneficiary other than the executor. An exception exists for proceeds left to a surviving spouse that qualify for the marital deduction; these amounts are not subject to the recovery right. Unless the decedent has made specific arrangements to the contrary in their will, the executor is empowered to seek this reimbursement.

Calculating the Beneficiary’s Share of Tax

The amount an executor can recover is not arbitrary; it is calculated based on a proportional formula. The law states that the recoverable amount is the portion of the total tax paid that the life insurance proceeds bear to the decedent’s total taxable estate. This ensures the beneficiary pays a share of the tax equivalent to the amount of tax their proceeds generated.

The calculation is performed by dividing the value of the life insurance proceeds by the value of the total taxable estate, and then multiplying that ratio by the total federal estate tax paid. The taxable estate is a value calculated on the estate tax return; it is the gross estate minus all allowable deductions, such as debts, administrative expenses, and marital or charitable deductions. The total federal estate tax paid is the final tax liability shown on the return after all credits are applied.

For example, imagine a decedent’s taxable estate is $15,000,000, which includes a $1,500,000 life insurance policy. If the total federal estate tax paid by the estate is $400,000, the beneficiary’s share can be calculated. The life insurance proceeds ($1,500,000) are divided by the total taxable estate ($15,000,000), which equals 10%. This percentage is then multiplied by the total estate tax ($400,000), resulting in a $40,000 liability for the beneficiary.

Overriding the Default Rule in a Will

The executor’s right to recover estate taxes from a life insurance beneficiary is the default rule, but it is not absolute. A decedent can override this provision and direct that the beneficiary receive the insurance proceeds free of any tax burden. To do this, the decedent must include a specific directive in their will.

A general clause in the will stating that “all taxes shall be paid from my residuary estate” may not be sufficient to waive the executor’s right of recovery. While some state courts have interpreted such language broadly, federal law and many state courts require more explicit language to override a federal statute. The will should specifically mention the tax burden from non-probate assets like life insurance and clearly state the intention to waive reimbursement.

For a waiver to be effective, the language must be unambiguous. A tax clause might state that all death taxes, including those attributable to property passing outside of the will, shall be paid from the residue of the estate without reimbursement from any recipient. Without this level of specificity, an executor may still be obligated to pursue recovery. If the will is silent or ambiguous, the default federal rule applies, and the beneficiary must contribute their proportional share.