Connecting Lawyers with Expert Witnesses

Dear California Estate Tax Planning Colleague:

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The South Dakota Supreme Court’s recent decision in VIVA Capital Trust v. Garrett, 2026 S.D. 42, deserves close attention from California estate tax planning attorneys. Although the case did not address a federal tax issue, it has important practical implications for attorneys who structure irrevocable life insurance trusts (ILITs), advise high-net-worth real estate families, or coordinate premium-financed life insurance planning. Most notably, the court recognized that life insurance intended to provide liquidity for estate taxes can serve as evidence of a legitimate estate-planning purpose rather than an indication of a stranger-originated life insurance (STOLI) arrangement.

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In VIVA Capital Trust, the insured was a California retiree and Bay Area real estate investor whose estate included substantial real estate holdings. A $10 million life insurance policy was acquired through an irrevocable trust and funded through a premium-financing arrangement. Following the insured’s death, his estate challenged the policy as an unlawful STOLI transaction and sought to recover the death benefit from its subsequent owner. The South Dakota Supreme Court rejected that challenge, emphasizing that the insured had significant real estate assets, potential estate-tax liquidity needs, and a family beneficiary structure consistent with conventional ILIT planning. The court also recognized that the policy was originally acquired for legitimate estate-planning purposes, including providing liquidity to pay estate taxes without forcing the family to sell valuable assets.

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For California estate tax planning attorneys, this decision is particularly relevant because many clients have similar financial circumstances, including high-value, low-basis and illiquid real estate, family-owned businesses, and potential estate-tax exposure. The decision reinforces the importance of documenting the purpose of life insurance at the time it is acquired, including why the amount of coverage, ownership structure, and premium-financing arrangement are appropriate. A well-prepared ILIT file should demonstrate a legitimate estate-planning objective rather than simply technical compliance with insurable-interest requirements. California practitioners must also recognize that California's current anti-STOLI statutory framework is more restrictive than the legal environment governing the 2006 transaction in VIVA Capital Trust. California law specifically addresses trusts and special-purpose entities used to create the appearance of an insurable interest when the actual economic beneficiary is a third-party investor. See California SB 98, Chapter 343.

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Importantly, the decision does not establish that every premium-financed ILIT is protected from STOLI scrutiny. The transaction involved several factors that can raise concerns, including an elderly insured, a substantial policy, nonrecourse premium financing, a lender-influenced trust structure, and a subsequent transfer into the secondary market. What ultimately supported the policy's legitimacy was the court's conclusion that the evidence did not establish an agreement at the inception of the policy to transfer it to outside investors. The court also gave weight to the evidence supporting a genuine estate-planning purpose. For California practitioners, this distinction is critical. Premium financing may be an appropriate planning tool for clients with substantial illiquid wealth, but the supporting documentation must be developed before the policy is issued, rather than relying on testimony or explanations years after the transaction.

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In light of this decision, California estate tax planning attorneys should consider maintaining a comprehensive file for significant ILIT and premium-financed life insurance arrangements. This should include a written estate-tax liquidity analysis, a balance-sheet summary identifying the client's illiquid assets, a reasoned explanation for the policy's face amount, and documentation of both tax and non-tax objectives. The file should also address whether any prearranged sale or transfer of the policy exists, disclose and analyze all premium-financing terms, document the trustee's independent review and approval, and establish the beneficiaries' legitimate insurable-interest relationships. In addition, attorneys should review applicable California anti-STOLI statutes and life-settlement rules and obtain separate tax analyses addressing estate inclusion, gift-tax treatment, transfer-for-value issues, grantor trust status, and applicable split-dollar or financing rules.

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The decision also provides an important opportunity to educate clients about the value of thoughtful estate planning. The question is not simply whether an irrevocable life insurance trust can own a policy, but whether the client's planning file will demonstrate years later that the insurance was acquired for legitimate estate-tax liquidity and family-protection purposes. For California families with substantial real estate portfolios, life insurance can remain an effective tool for creating liquidity at death. However, VIVA Capital Trust illustrates that the strength of the plan depends not only on the trust instrument and policy structure but also on contemporaneous documentation establishing that the transaction reflects legitimate estate planning rather than investor-driven policy origination.

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Although VIVA Capital Trust v. Garrett is not a federal tax decision, it is an important development for California estate tax planning practitioners. The ruling confirms that estate-tax liquidity needs can be persuasive evidence supporting the legitimacy of an ILIT-owned life insurance policy, particularly when the insured owns substantial illiquid real estate or other significant assets. Nevertheless, California attorneys should not view the decision as a safe harbor. California's anti-STOLI requirements warrant careful review, and premium-financed life insurance arrangements should be thoroughly documented from the outset. For clients with substantial California real estate holdings or other illiquid assets who are considering ILIT-owned life insurance or premium financing, this decision is a timely reminder to revisit the planning strategy, confirm the estate-tax rationale, and ensure the structure is prepared to withstand future scrutiny.

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Sincerely,

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Brian A. Sullivan, CPA/ABV

SULLIVAN & COMPANY CPA INC

brian@sullivancocpa.com

Cell: 650.730.9848