Minnesota Estate Tax: Life Insurance, ILITs, and Form M706

In Minnesota, life insurance proceeds are counted as part of your taxable estate whenever the policy was payable to your estate or you held any meaningful control over it at death, even though the beneficiary receives the money income-tax-free. That matters because Minnesota’s estate tax exemption is only $3 million, and a single policy’s death benefit is often enough to push an otherwise exempt estate across the line and into a tax bracket that starts at 13 percent.¹

Minnesota does not write its own rules for life insurance inclusion. The state defines its gross estate by reference to the federal gross estate under the Internal Revenue Code, so the federal rule in 26 U.S.C. § 2042 governs here by direct incorporation.²³ If a policy is in the federal gross estate, it is in the Minnesota gross estate.

When a Policy Gets Pulled Into the Estate

Two situations trigger inclusion. The first is simple: the death benefit is payable to your estate or your executor. The second is broader and catches most people by surprise: you held any “incidents of ownership” in the policy when you died, and in that case the full death benefit is included no matter who the named beneficiary is.³

Incidents of ownership covers any meaningful control: the right to change the beneficiary, cancel or surrender the policy, assign it, borrow against its cash value, or pledge it as collateral.⁴ You do not have to have exercised any of these powers. Having the legal right is enough. A reversionary interest also counts if its value exceeds 5 percent of the policy’s value immediately before death, which catches arrangements where ownership moved to someone else but a realistic path existed for the policy to come back.³

Even without any ownership rights, proceeds land in the gross estate if they benefit the estate indirectly. Naming the estate as beneficiary does it. So does an arrangement where the beneficiary has a legal obligation to use the proceeds to pay estate debts, taxes, or other charges, or where the policy has been pledged as collateral for a loan.⁴ A well-meaning plan to “help the family pay estate costs” can pull the entire death benefit into the taxable estate this way.

The Corporate-Owned Policy Trap

Business owners face a specific risk. When a corporation owns a policy on a shareholder’s life, the corporation’s control is attributed back to the shareholder if they owned more than 50 percent of the voting stock at death, and the proceeds go to someone other than the corporation for a purpose unrelated to business.⁴

The exception matters: if the proceeds are payable to the corporation itself, or to a third party to satisfy a legitimate business debt, the corporation’s incidents of ownership are not attributed to the shareholder. A policy funding a buy-sell where proceeds go to the corporation to purchase the deceased shareholder’s stock is generally safe. A policy where proceeds go directly to family members for personal benefit is not.

The Three-Year Lookback on Transfers

Transferring ownership of a policy does not immediately remove it from your estate. Under IRC § 2035, if you transfer a policy or give up any incident of ownership and die within three years, the full death benefit snaps back into your gross estate as though the transfer never happened.⁵ Minnesota picks this up through its incorporation of the federal gross estate.²

The clock starts when the ownership change is completed with the carrier, not when you decide to transfer. Survive the three full years and the proceeds stay outside the estate. Wait until a terminal diagnosis to transfer, and the three-year window almost always catches it.

One narrow exception: the three-year rule does not apply to a transfer made as a genuine sale for full and adequate consideration.⁴ Most family or trust transfers are gifts, not sales, so the lookback usually applies.

Keeping the Proceeds Out With an Irrevocable Life Insurance Trust

The standard tool for keeping a policy out of a Minnesota taxable estate is an irrevocable life insurance trust. The trust owns the policy, pays the premiums, and receives the death benefit. Because you do not own the policy, the proceeds stay out of the federal and Minnesota gross estates if the structure holds up.

The requirements are strict. The trust must be genuinely irrevocable: you cannot change its terms, reclaim the policy, or dissolve it.⁶ You must give up every incident of ownership, and you cannot serve as trustee. An independent trustee handles premium payments and beneficiary communications. If the trust leaves you any residual power over the policy, the IRS treats you as the owner and the proceeds come back into the estate.

The trust should also be drafted so its proceeds cannot be used to pay your estate’s debts or taxes. If the trustee is required or even permitted to cover estate obligations, the proceeds can be treated as receivable for the estate’s benefit, which triggers inclusion regardless of legal ownership.

When you contribute money to the trust so it can pay premiums, those transfers are gifts. Most ILITs use Crummey withdrawal powers to make them qualify for the annual gift tax exclusion: each time you contribute, beneficiaries receive a written notice giving them a temporary right, usually 30 days, to withdraw the contribution. Because they could take the money, the IRS treats it as a present-interest gift.

One important sequencing point. If you transfer an existing policy into a newly created ILIT, the three-year lookback applies and the death benefit comes back into your estate if you die within three years.⁵ Having the trust apply for and purchase a brand-new policy avoids this entirely, because you never owned the policy to begin with.

How Much the Inclusion Actually Costs

The Minnesota taxable estate is the federal taxable estate with a few state-specific adjustments, including an add-back of taxable gifts made within three years of death. Minnesota then subtracts a $3 million exclusion. If the result is zero or negative, no tax is owed. Above that threshold, tax runs through five progressive brackets:⁷

Up to $7,100,000: 13 percent
$7,100,001 to $8,100,000: $923,000 plus 13.6 percent of the excess over $7,100,000
$8,100,001 to $9,100,000: $1,059,000 plus 14.4 percent of the excess over $8,100,000
$9,100,001 to $10,100,000: $1,203,000 plus 15.2 percent of the excess over $9,100,000
Over $10,100,000: $1,355,000 plus 16 percent of the excess over $10,100,000

Concrete numbers: a Minnesota resident who dies with a $4 million estate that includes a $1 million policy triggering inclusion has a Minnesota taxable estate of $1 million. At 13 percent, the tax is $130,000. Without the policy inclusion, the estate sits at $3 million and owes nothing.

The Marital Deduction, and Why Minnesota Couples Need to Plan

Property passing outright to a surviving spouse qualifies for the federal marital deduction under IRC § 2056, which flows through to Minnesota because the state uses the federal taxable estate as its starting point.⁸ Life insurance payable to a surviving spouse qualifies too. A $2 million policy pulled into the gross estate but paid to the spouse produces no state tax at the first death. Of roughly 50,000 deaths in Minnesota each year, only a few hundred estates actually pay the tax, largely because of this deduction.¹

The marital deduction only defers the tax. Whatever remains from those proceeds joins the surviving spouse’s estate, and here Minnesota adds a sharper edge: unlike federal law, Minnesota does not allow portability of a deceased spouse’s unused $3 million exclusion. Each spouse gets $3 million, and any unused portion disappears at death. A married couple with everything titled in one spouse’s name can waste the other spouse’s entire exclusion. Combining a marital deduction strategy at the first death with an ILIT for the surviving spouse’s own coverage is often the only way to use both exclusions in full.

Reporting Life Insurance on Form M706

Every policy on the decedent’s life has to be reported on Form M706, whether or not the estate claims the proceeds are excludable. The executor obtains IRS Form 712 from each insurance carrier, which gives the official death benefit, accumulated dividends or interest, and any outstanding policy loans reducing the payout.⁹

The return lists the insurance company, policy number, beneficiary designations, and amount of the proceeds on the insurance schedule, and the figures should match any federal Form 706 filed with the IRS.¹⁰ If the executor is claiming an ILIT-owned policy should be excluded, the return should include supporting documentation, such as the trust agreement and the carrier’s ownership records.

Filing Deadline and Penalties

Form M706 is due nine months after the date of death. The estate can get an automatic six-month filing extension (or longer, if the IRS grants additional time on the federal return), but a filing extension does not extend the time to pay. The full estimated tax is still due within nine months.¹⁰

Late penalties stack. The late-payment penalty is 6 percent of any tax not paid by the regular due date. Another 5 percent applies if the return is filed late and the tax is not paid in full at filing. The late-filing penalty itself is a further 5 percent. Interest accrues at 7 percent for 2026, compounding from the original due date.¹¹ Penalties can be avoided if the estate pays at least 90 percent of the tax by the regular due date and the remainder by the extended due date. Estates with a federal extension to pay, or an installment election, may qualify for additional relief.

1
Minnesota House of Representatives. The Minnesota Estate Tax
2
Minnesota Office of the Revisor of Statutes. Minnesota Code 291.005 – Definitions
3
Office of the Law Revision Counsel. 26 USC 2042 – Proceeds of Life Insurance
4
eCFR. 26 CFR 20.2042-1 – Proceeds of Life Insurance
5
Office of the Law Revision Counsel. 26 USC 2035 – Adjustments for Certain Gifts Made Within 3 Years of Decedents Death
6
Minnesota Attorney General. Living Trusts
7
Minnesota Office of the Revisor of Statutes. Minnesota Code Chapter 291 – Estate Tax, Section 291.03
8
Minnesota Office of the Revisor of Statutes. Minnesota Code Chapter 291 – Estate Tax, Section 291.016
9
Internal Revenue Service. About Form 712, Life Insurance Statement
10
Minnesota Department of Revenue. 2024 Estate Tax Form M706 Instructions
11
Minnesota Department of Revenue. Penalties and Interest for Businesses