Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com 11-1 Three Business Life Insurance Objectives Objective 1: Key Person Insurance. Protect business from death of a key player. Objective 2: Buy-Out or Obligation Discharge Insurance. Fund company’s obligation under buy-sell agreement, SERP, deferred compensation plan, etc. Objective 3: Family Protection insurance. Provide executive’s family with protection.

Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com 11-2 Tips on Keeping Objectives Straight Deal with each objective separately Use multiple polices Use a written insurance memorandum Watch the tax traps and angles

Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com 11-3 Ownership Options Option 1: Company owns policy Option 2: Insured executive/shareholder owns policy Option 3: Insured’s co-owners own policy Option 4: Ownership is “Split” between company and insured. Note: Who owns doesn’t control who must bear the economic burden of the premiums on policy, but does impact tax consequences of premium payments.

Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com 11-4 Split Dollar Insurance What it is? Contract between company and employee that “splits” the benefits offered under a life insurance policy on employee’s life. Typical Split: At death company gets greater of aggregate premiums it has paid or cash surrender value of policy. Excess of death benefit over company’s share is paid to employee’s designated beneficiary or ILIT established by employee to own share. Two ways to structure: - Endorsement Method: Company owns and controls policy and uses endorsement on policy to reflect interest of employee or ILIT. - Collateral Assignment Method: Employee or ILIT owns and controls policy and collaterally assigns policy to company to secure company’s interest in policy proceeds.

Split Dollar Insurance Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com 11-5 Company Insurance Company Premiums Portion of Death Benefit Employee/ Insured Policy Ownership Summary of impacts: Premiums paid by company treated as below-market loans to employee/insured Compensation imputed to employee for interest element Interest payment imputed from employee to company Collateral Assigned Policy Excess Death Benefit Policy Collateral Assignment

Split Dollar Insurance Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com 11-6 Company Insurance Company Premiums Portion of Death Benefit Employee/ Insured Policy Ownership Summary of impacts: Company owns policy, not employee Company endorses policy to reflect employee’s interest in death benefit Employee each year deemed to have received compensation income for death benefit value over share (if any) paid by employee Company gets corresponding compensation deduction Endorsement Method Excess Death Benefit Policy Endorsed

Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com 11-7 Common Insurance Tax Traps 1.Tax-free death benefit trapped inside C corp with no pass-thu. 2.Tax-free death benefit partially trapped inside of S Corp because of accumulated E&P from C Corp years. S Corp stockholders basis is increased pro rata by insurance but not S corp’s accumulated adjustment account. Plus, if multiple shareholders, may have basis allocation problem. 3.Premium disguised dividend trap – corporation pays premium on policy owned by shareholder. 4.Co-owner cross purchase disguised dividend trap.

Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com 11-9 Common Insurance Tax Traps 5.Transfer-for-value on transfers among co-owners. Destroy income tax-free death benefit. Exceptions under 101(b) for transfers to insured, to partner, to partnership if insured partner, to corp if insured shareholder or employee. No exception for: Policy transfers from corp: From redemption to cross purchase Transfers among co-shareholders Transfer from insured to co-shareholder 6.Corporate alternative minimum tax trap – If C corp with receipts over 7.5 mill, 75% of death benefit over premiums and growth in cash value subject to corporate AMT.

Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com Common Insurance Tax Traps 7.Majority Shareholder Trap: Any incidents of ownership in policy owned by corporation will be attributed to more than 50% stockholder. Can mess up ILIT planning big time. If ILIT used with split dollar, use collateral assignment approach to deny corp any control rights over policy. 8.Corporate owned insurance estate tax impact. Not included in estate of majority shareholder/insured, but does impact estate value. Great value under Huntsman to structure buy-out and valuation to water down inclusion impact. For non-majority, may eliminate completely by smart agreement.