Life Insurance to Fund a Buy Sell Agreement
Taxation of Death Benefit
Cross Purchase Agreement
Is there any need to create a 'trust' to own the life insurance and be the beneficiary?
Only 2 Shareholders, 50% ownership each
This is an S. Corp
It has been recommend to me to advise my clients to have a "cross purchase agreement" completed but that also they should have a trust own the life insurance and be the beneficiary with planning to also avoid a "Transfer of Value" situation that could make the death benefit taxable.
I have been told that if my 2 shareholders jointly own the life insurance it could open itself to being determined as a transfer of value situation, making the proceeds taxable to the beneficiary or possible a gift tax. I have been also been told that it would add to the decedent’s estate which I already understand and is not a concern for my clients.
However in this case there are only 2 shareholders so I disagree with the help I got from my back office and I believe an additional trust is not needed.
Here are the details and how I see it. I don’t believe my scenario would result in any transfer of value situations with any future life insurance proceeds and it would not produce a gift tax situation. Please point out to me and explain if I am wrong:
Shareholder A and Shareholder B own jointly policies with Shareholder A as Insured and Shareholder B as Beneficiary.
Shareholder A and Shareholder B own jointly policies with Shareholder B as Insured and Shareholder A as Beneficiary.
They own these policies jointly so any disparity in premiums, cash values etc. are solved because they jointly have access to the values of the contracts and both pay ½ of the premium total. – This is important.
They enter into a cross purchase agreement that states upon the death of one of the two shareholders of XYZ Telecom Corp that the survivor will buy the shares owned by the decedent for a set price ($250,000) and the decedent’s estate will be required to sell those shares to the survivor at that price.
If, for example, shareholder A dies
Shareholder B will receive death benefit tax free (there would have been no transfer of value here).
Shareholder B will pay the set amount ($250,000) to the estate of Shareholder A.
Shareholder A’s estate will pay no income tax on this because it just became the agreed upon value of those shares and that becomes their basis. Shareholder A’s estate’s basis in those shares would be equal to that amount.
Shareholder B’s cost basis for those shares he is obligated to buy would be equal to the set price also.
Shareholder B will assume full ownership of the remaining polices and since he is also the insured this would be exempt from any transfer of value tax on future death benefits.
What happens if one of the shareholder’s wants out and is bought out by the other shareholder?
They could simply change the ownership on the policies so Shareholder A will own the policy in which he is insured and Shareholder B would own the policy in which he is insured and they could settle up on the disparity between the cash value of the policies at that time by paying the other for the value difference. Again because the owner of the policy will become the insured it would be exempt from being a transfer of value.
Yep, that's it :-)