Gifts of life insurance are treated in the same manner as gifts of any other asset as far as the $10,000 annual exclusion or the gift tax provisions. That is, the outright gift of a policy is a transfer of property that provides a present interest and is subject to gift taxes when the transfer is made.

To thoroughly understand all the ramifications of federal gift taxation triggered by transferring a life insurance policy for "insufficient consideration in money or money�s worth," it is useful to review the principles of life insurance policy valuation. The value of the policy at the time of the gift becomes the tax base of the transfer for gift tax purposes.

The value of a life policy that has been gifted depends on the type of policy and the timing of the transfer. Gift and estate tax regulations provide a method for determining the value of a policy.

If the policy is paid up at the time it is transferred (or is a single-premium policy), the gift tax value of the policy is the amount of premium the issuing insurer would charge as a single premium for the same type of policy of equal face amount on the insured�s life, based on the insured�s age at the transfer date. An insured�s impaired health is not addressed by the Treasury regulations, but the IRS has argued that the insured�s adverse health at the time of the policy gift increases its valuation.

If the policy is in a premium-paying state at the time it is transferred, the gift tax value of the gift is generally equal to the sum of (1) the interpolated terminal reserve and (2) the unearned premium on the date of the gift.

The terminal reserve at the end of the current year $70,000

The terminal reserve at the end of last year �50,000

The increase in the terminal reserve over

the current year $20,000

· · ·

One-half of the increase in the terminal reserve

(the increase in terminal reserve at the time

of the gift halfway through the year) $10,000

The terminal reserve at the end of last year +50,000

Interpolated terminal reserve $60,000

· · ·

The interpolated terminal reserve $60,000

One-half annual premium (amount unearned

at the time of gift) +7,500

Value of policy at the time of gift $67,500

Often a donor will continue to pay annual premiums, even after an absolute transfer of the insurance has been made. Each premium paid subsequent to the policy�s transfer is considered a gift. As long as the transfer is outright to a donee, the gift of the policy is one of a "present interest." Therefore, the $10,000 annual gift tax exclusion will be applicable, not only to the gift of the policy itself but also to the gift of each premium payment as it is made. However, when gifts of life insurance policies are made in trust, the exclusion is forfeited unless the donee has at least a temporary unrestricted power of withdrawal over the property transferred to the trust.

Sometimes there is an inadvertent gift of life insurance policy proceeds. This can happen when a policy owned by one individual on another�s life matures by reason of the insured�s death and a person other than the policyowner has been named as beneficiary. For example, if a wife purchases a policy on her husband�s life and names her children as beneficiaries, the proceeds that otherwise would have been payable to her are payable instead to her children at her husband�s death. The transaction is treated as if the policyowner (the wife) had received the proceeds and made a gift in that amount to her children. Moreover, gift splitting is not allowed, since there is no longer a spouse with whom to split the gift.