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Court Says No Iowa Estate Tax on Life Insurance Proceeds That Aren’t Included in the Probate Estate

- by Erin Herbold

October 9, 2009

The decedent died in 1998.  At the time of his death he had two sons that were named as beneficiaries of his life insurance policy.  The decedent’s estate was probated but, of course, the life insurance policy was not included in the probate estate – it’s “bypass” or “will substitute” property via the beneficiary designations.  After payment of administrative expenses, the estate lacked the funds to pay the federal and Iowa estate taxes.  When it was closed, the estate was insolvent, and the two surviving sons did not inherit any probate assets.

In 2004, the IDOR assessed Iowa estate tax of approximately $31,000 against the two sons- attempting to collect the tax through a levy on the life insurance proceeds that they received.   The parties agreed that the proceeds of the insurance policy were not includable in or taxable to the probate estate for inheritance tax purposes- though they were included in the decedent’s gross estate.  Under Iowa Code Ch. 450, life insurance proceeds that are paid to a “named beneficiary” are exempt from Iowa inheritance tax.  The sons paid the tax and sued for a refund.

An administrative law judge (ALJ) ruled that the IDOR was not authorized to collect the estate tax from the sons. The IDOR appealed and the director of the IDOR reversed the ALJ’s decision. The trial court affirmed the director’s decision and the sons appealed to the Iowa Court of Appeals.

While Iowa law (Iowa Code§451.6) specifies that the estate tax imposed shall be paid by the personal representative (here, the sons), the appellate court noted that does not mean that the personal representative has personal liability for the taxes. The tax is the estate’s responsibility, not the personal representative’s.  In addition, Iowa law does not authorize the collection of Iowa estate tax from non-probate assets. In addition, the appellate court noted that Iowa Code §450.7 excludes children and other lineal descendants, such as parents and spouses, from being subject to a tax lien. Thus, the beneficiaries were entitled to a refund of tax, penalties and interest. As the prevailing taxpayers, the brothers were also entitled to their “reasonable costs of litigation.” Tremel v. Iowa Dept. of Rev., No. 9-592/08-1718 (Iowa Ct. App., Oct. 7, 2009).