BGBC Partners, LLP Tax Update: Life Insurance in Your Business
Benjamin Franklin once said “…nothing can be said to be certain, except death and taxes!”
As a business owner you know that both death and taxes can have a significant impact on your business. Therefore, it is prudent to plan for both events, and Life Insurance is the rare tool that allows a business to do so simultaneously! And that is the topic of this week’s Tax Update – how to strategically use life insurance to prepare for the death of an owner in the most tax-efficient manner.
Although there are several situations which may call for the use of life insurance, the primary context we will focus on is how to use life insurance to fund a Buy-Sell Agreement upon the death of a shareholder.
A Buy-Sell Agreement is a contract which restricts the ability of shareholders or partners to freely transfer their ownership interests. The contract often provides that an owner’s interest will be sold to the other owners or to the business itself on the occurrence of some event, at a specified price. This prevents the addition of unwanted owners into the corporation or partnership.
One of these “triggering events” could be the death of an owner. A Buy-Sell Agreement will prevent a spouse or children of the decedent from attaining an ownership interest.
So where does the life insurance come in? The life insurance is the tool that funds the actual purchase of the shares from the estate or heirs of the deceased owner.
For example, assume two shareholders own an S corporation, and agree that if one them dies, the surviving shareholder will purchase the interest from the estate. Each shareholder can purchase a life insurance policy on the other’s life. In the event of the death of the other shareholder, the surviving shareholder uses the proceeds from the life insurance policy and pays the decedent’s estate for the shares. This is known as a “cross-purchase” since the transaction is across the owner level.
Another variant of this is a “redemption buy-sell agreement” in which the company purchases a policy on a shareholder’s life, and upon the death of the shareholder, the Company uses the life insurance proceeds to redeem the shares from the estate or heirs.
What are the general tax considerations?
Generally, life insurance premiums are not deductible and the receipt of the proceeds upon the triggering event is nontaxable. However, there may be alternative minimum tax implications for a C corporation due to the complexities of the ACE adjustment. Also, there are special rules which tax an employer on life insurance proceeds from the death of employees.
Using life insurance as a strategic tool can be very effective, but also very complex. Therefore, you should consult your CPA to determine whether life insurance fits within your overall business plan.
