1. Business Planning Using Life Insurance
Retain, Recruit and Reward
Purpose and Scope of this Presentation. This presentation is intended to be used by Sales Offices to give producers a broad overview of business life insurance plans. It is intended to educate producers on the opportunities, benefits and applicability of the business uses of life insurance.
AimcoR Group, LLC offers this presentation to qualified users to assist them in adding value to their customer relationships. This presentation should not be construed as a specific “plan” or specific legal, tax or accounting advice. Whether any of the presentation topics are applicable to specific individuals can only be determined by the individual and his or her professional advisors.
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2. Buy-Sell Arrangements
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3. Buy-Sell Arrangements
A buy-sell arrangement is a binding agreement in which one party agrees to sell the interest and the other party will buy the interest.
Transactions occur
At death
At retirement
At disability
A buy-sell arrangement is a way to plan for the sale of a business interest upon a triggering event such as an owner’s death, disability, or retirement. A well-drafted and properly funded arrangement can protect the interests of the business owners and help facilitate the continuation of the business when they are needed most – at the death of an owner.
Create Liquidity. Upon a business owner’s death, retirement, or disability, his or her family continues to need cash to pay ordinary living expenses as well as any potential estate tax liability. Estate taxes are usually due nine months after date of death. Selling a business under these circumstances can result in the family receiving less than fair market value.
Set a Fair Selling Price. A business valuation strategy that is determined while all owners are active can be negotiated at arm’s length. Once a business owner leaves the business, negotiating a fair sales price becomes more difficult for the owner (or the owner’s estate) because the remaining owners hold most of the cards.
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4. Types of Buy-Sell Arrangements
Stock Redemption or Entity Purchase
Cross Purchase
Wait and See
Buy-sell arrangements can take different forms, including: (1) stock redemption or entity purchase, (2) cross-purchase, and (3) wait and see.
The best type of arrangement depends upon several factors, including the type of business structure and the number of owners.
An entity purchase arrangement allows a business to buy out its deceased owners, while a cross-purchase arrangement allows business owners to buy each other out.
A wait and see arrangement is a combination of the first two types.
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5. Stock Redemption or Entity Plan
The business agrees to buy life insurance on the lives of the owners
Agreement states that the owners or their estates agree to sell interest in the business and the business agrees to buy it.
Business is the owner and beneficiary of the life insurance policy.
In this case the business will purchase the ownership/shares from the owners. It usually is a straight forward method.
If life insurance is used to fund the plan, the business is the owner and beneficiary of the policies.
A Stock Redemption or Entity Plan is the most efficient when:
The  plan requires several policies because of the number of owners, typically, more than three to five owners.
If the corporation is in a lower income tax bracket than its individual owners or if there is a concern that an individual shareholder (s) will have trouble paying the premiums or concern about the policies lapsing.
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6. Stock Redemption or Entity Plan
During Lifetime
Insurance Co.
Pays Premiums
Business
Agreement
Agreement
Plan: Buy-Sell Arrangement –Stock Redemption or Entity Purchase
During the lifetime of the owners the business pays for life insurance on the lives of each owner. Only one policy is necessary per owner.
Objective: Disposal of the business interest upon the death of an owner, by having the business purchase deceased’s interest.
Premium Payor: Business.
Owner: Business.
Beneficiary: Business – proceeds are used by the business to buy the interest from the deceased’s owners estate.
Income Tax Issues:
Business: Premiums are not income tax deductible. Proceeds are not income taxable. “S” corporations will generally get a step up in basis on the entity redemption, but a “C” corporation will not.
Employee: None
Deceased’s Family: Step-up in basis usually applies. If the payments do not exceed stepped-up basis, there are no income tax consequences.
Estate Impact: Purchase price paid for the deceased’s business interest is included in the gross estate. This usually equals the amount of the policy proceeds.
Owner A
Owner B
The Business owns insurance policies on each owner
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7. Stock Redemption or Entity Plan
Upon A’s Death
Pays Death Benefit
Insurance Co.
Stock Passes
Business
At the death of an owner, in this case A, the life insurance proceeds are received by the business. The business then purchases the stock or ownership in the business from A’s estate. In this example, B will be the 100% owner of the business and A’s family now has cash and is completely out of the business.
Business
Interest
Cash
Owner B
A’s Family or Estate
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8. Cross-Purchase Plan
Owners take life insurance policies out on each other
Survivor purchases deceased owner’s shares in company
Life insurance proceeds help to provide the funds
A cross-purchase buy-sell agreement is an arrangement in which each owner agrees to buy the business interest of another owner. A triggering event such as the death, disability, retirement, or other termination event of an owner may lead to an ownership transition. Thus, a cross-purchase plan reflects a business continuation agreement among the owners themselves. A cross-purchase plan usually works well with five or fewer owners.
Funding a cross-purchase plan typically requires multiple life insurance policies. The number of policies may be expressed as a formula with the number of shareholders (n) times the number of shareholders minus one (n-1). For example, if there are three owners, the implementation of a cross-purchase plan requires the use of six (3 times 2) policies. If there are five owners, the implementation of a cross-purchase plan requires the use of 20 (5 times 4) policies.
Individual owners may pay the premiums out of their personal funds or the corporation may decide to directly pay the premiums using either a “double” bonus or split dollar arrangement.
Individual owners receive death proceeds income tax free.
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9. Each Owner Obtains Insurance On the Other
Cross Purchase Plan
During Lifetime
Insurance Co.
Business
This flowchart shows a simple cross purchase plan between two owners, A and B.
Pays Premiums
Pays Premiums
Owner A
Owner B
Each Owner Obtains Insurance On the Other
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10. Advantages of Cross Purchase
Purchasing shareholder will get step-up in cost basis
Life insurance proceeds are income tax free
Avoids possible treatment of redemption as a dividend.
No AMT or accumulated earnings tax problems
Can reallocate ownership of the surviving owners by purchasing varying amounts of the deceased owner’s shares.
The purchasing owners receive a step-up in basis in the acquired stock. A step-up in basis reduces the taxable gain (or increases the loss) on a subsequent disposition of the stock
The receipt of life insurance proceeds will not be subject to income tax.
Life insurance used to fund the cross-purchase agreement does not increase the value of the corporation. The corporation does not reflect the value of the life insurance policies on its balance sheet.
A cross-purchase plan does not encounter the possibility that redemption proceeds will receive treatment as a dividend distribution. Furthermore, the family attribution rules do not apply to cross-purchase plans.
Since the corporation is not a party to a cross-purchase plan, no potential corporate AMT or accumulated earnings tax consequences exist for the policy proceeds.
With a lifetime sale, the selling owner recognizes capital gains to the extent that the purchase price exceeds his or her basis.
The death proceeds of life insurance owned by Owner A on Owner B’s life would not be part of Owner A’s estate for federal estate tax purposes.
If there are more than two surviving owners, they could purchase different percentages of the deceased owner’s interest to restructure the ownership percentages of the surviving owners.
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11. Cross Purchase Plan Upon A’s Death Business Stock Passes
Insurance Co.
Stock Passes
Pays Death Benefit
Business
Plan: Buy-Sell Arrangement - Cross Purchase
Objective: Disposal of the business interest upon the death of an owner, by transferring ownership to the surviving co-owners.
Premium Payor: Each partner or stockholder pays premiums for policy on the life of other partner (s) or co-stockholder (s).
Owner: Each partner or stockholder owns a policy of the life of partner (s) or co-stockholder (s).
Beneficiary: Each partner or stockholder is the beneficiary of the policy he/she owns on the life of the partner (s) or co-stockholder (s). Proceeds are used to buy the interest from the deceased’s owners estate.
Income Tax Issues:
Business: No issues, not a party to the plan.
Employee: Premiums not income tax deductible and the proceeds are not income taxable.
Deceased’s Family: Step-up in basis usually applies. If the payments do not exceed stepped-up basis, there is no income tax consequences.
Estate Impact: Purchase price paid for the deceased’s business interest is included in the gross estate. This usually equals the amount of the policy proceeds.
Business Interest
Cash
A’s Family or Estate
Owner B
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12. Wait and See Agreement
Owners agree to buy and sell their shares but the price is not determined until death, retirement or disability
Owners purchase life insurance on each other
Business has right of first refusal, owner second right, and the business must purchase remaining shares
This type of arrangement offers flexibility because the ultimate decision about who is going to buy what is not determined until the event occurs.
Normally, the business has the right of first refusal. In other words based on circumstances the business entity can purchase as much or as little of the business as it sees fit. Secondly the surviving business owners have an opportunity to purchase any remaining shares of the business. To the extent that there is any ownership shares remaining, the business entity is obligated to purchase the remainder.
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13. “Wait and See” funded by owners
During Lifetime
Pays Premiums
Insurance Co.
Business
Pays Premiums
Pays Premiums
Assume we have a corporation which is owned equally by A and B. As with both the cross purchase and stock redemption plans, the “wait and see” agreement provides for valuation of their interests; sale upon death, disability or retirement; and the specific terms of payment.
However, unlike the other plans, the “wait and see” buy/sell agreement does not specifically identify the purchaser. The purchaser and amounts of purchase are not determined until AFTER the death of one of the owners.
Let’s look at an example;
In our example we’re going to assume that A and B purchase life insurance contracts on each other. They will own the policies, pay the premiums and be the beneficiaries.
Notice that the structure in this case looks a lot like a cross purchase...the difference here is that the business entity is part of the agreement, whereas in the cross purchase plan the business entity is specifically excluded.
Agreement
Owner A
Owner B
Each Owner Obtains Insurance On the Other
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14. “Wait and See” funded by owners
Business
Upon A’s Death
Insurance Co.
Option to Purchase
Must Purchase
Death Benefit $
Stock Passes $
1st
3rd
At A’s death, his stock passes to his family or estate. At the same time, the insurance company pays an income tax free death benefit to B, as beneficiary of the contract he owns on A’s life. Exercising the agreement the following steps are implemented:
1st - The business has the first option to purchase A’s stock: typically the business has days to exercise its option.
2nd - If the business does not exercise its option, or purchases less than all of A’s stock, B has a second option to purchase A’s stock: typically B has days to exercise his option.
3rd - The business is required to purchase any of A’s stock not previously purchased by either the business or B.
Under the 1st and 3rd steps the business could obtain funds for purchasing A’s stock by borrowing the death proceeds received by B. As with the cross purchase and redemption agreements, the “wait and see” buy/sell agreement can also serve to help “peg” the value of the stock for estate tax purposes.
2nd
Owner B $
Option to Purchase
A’s Family or Estate
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15. Business Planning Using Life Insurance
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