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Robin D.
Robin D., Senior Tax Advisor 4
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Experience:  15years with H & R Block. Divisional leader, Instructor
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Life Insurance to Fund a Buy Sell AgreementTaxation of Death

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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 :-)

Robin D. :

Hello and thanks for trusting me to help you today. I am a tax adviser with over 15 years of experience.
The cross purchase agreement is a good idea. The specifics of the set up are what should be addressed.

If the business owners enter into a Cross Purchase Buy-Sell Agreement, each owner purchases a life insurance policy on the life of the other owner, pays the premiums to the insurance company and is named beneficiary to the policy.
This is not a problem. Proceeds would not be taxable to the beneficiary in this way.
If you have them purchase together that is where the water gets murky and why the Trust was advised.

If one owner dies, the insurance company pays the death benefit to the surviving owner. Each person should take out the policy on the other, then there would not be tax when pay out occurs.

Robin D. :

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,

This is the part of the situation that is causing the problem.

Robin D. :

If you want to continue in this action to make sure the Life Insurance is not taxable and the funding of the Buy Sell Agreement is made with Life Insurance then they both should not own the policies jointly.

A Buy-Sell Agreement is a plan where each surviving owner is obligated to buy the respective interests of their co-owners. It will be cleaner if they each own the individual policies on the other.

Robin D. :

I sincerely XXXXX XXXXX information is helpful and I would suggest if you have more questions about this you go over them again with the back office. I feel sure they advised you of the Trust because of the joint ownership situation.



Robin D. :

Did you have a chance to read the above?


I did, however I do not understand why if they both owned the policies jointly why that would be a problem. I could see the issue if there were more than 2 people involved but with just 2 people I think it would be ok for them to own the policies jointly.


I did read it. thanks

Robin D. :

No that is where it gets complicated. The funding on this to be made the easy process it was intended for would be for them to purchase the policies separately.


Yes I did read it. But I do not understand why if there is only 2 people involved why they could not own the policies jointly.

Robin D. :

Why do they want the policies joint? The funds are intended to really buy out the survivors.


because the life insurance will have cash values, there will be different premiums and by owning them jointly it would solve the discrepancy problem

Robin D. :

By owning them jointly they would be taxed on amounts over premiums on their portion .


how would that happen?

Robin D. :

If they own the policy too the payout would not be tax free (not totally) they would in effect be getting a cash out.

Robin D. :

Their portion would be added to the estate. If they do not have an ownership in the policy then the amount paid out is tax free to beneficiaries.

Robin D. :

If you insist on this course then follow the advice of your back office and have the trust setup.

Robin D. :

If they can go the route of buying a policy on the other (would be used to buyout the survivors) they woudl not have a tax isue and step up in basis would be allowed.

Robin D. :

The surviving shareholder would be entitled to a tax basis equal to the purchase price. The stepped-up basis should reduce future income taxes if the surviving shareholder later sell their interests.


Ok. so your saying I am wrong in my detail only because the surviving shareholder would not get a step up in basis when he buys the shares from the estate of the deceased shareholder?

Robin D. :

That and the fact that payout would not be totally tax free.


I don't understand why the payout would not be tax free.. just because they jointly own the life insurance?

Robin D. :

Because the one that dies would own a portion. Their payout over premiums paid would be added to their estate.


Oh Ok.. I see now.. thank you

Robin D. :

You are most welcome

Robin D. :

Your positive rating is thanks enough.

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