Because a sole proprietor and his or her business are considered one and the same, the proprietor's death can also mean the death of the business. However, as you've seen, there are other possibilities that do not result in the end of the business. When a sole proprietor dies, here are the three basic options:
1. The proprietorship is dissolved.
2. The proprietor's heirs continue operating the business, either as a new proprietorship or under some other form of ownership.
3. The proprietor's heirs sell the business.
Which of these options is the best choice depends upon the primary needs, i.e., paying for final expenses associated with the proprietor's death; administering the estate as quickly and efficiently as possible, funding on-going living expenses.
Assuming the estate closure leaves the business sufficiently intact that continued operation seems feasible, there is the additional consideration of whether or not the heirs actually should continue the business which should be addressed before the proprietor makes a Will and arranges for life insurance to continue the business.
Very often, there is the vision of the family continuing the business with ownership going from generation to generation. The problem is that heirs may not want to continue the business, or if they have the desire, frequently they are unable to continue the business. Some very basic questions about whether heirs will be able to continue the business successfully include:
1. Were the heirs’ active in the business before the proprietors died and, therefore are they knowledgeable about the business?
2. Do they have the necessary skills, separately or collectively, to manage aspects of a business?
3. Which of these heirs will be the decision-maker(s) and are they qualified?
4. Will the other heirs defer to the decision-maker(s) or will tensions arise over who is actually in charge?
There are several possible scenarios for heirs' continuing the business, depending on exactly who the heirs are, whether they want to be involved In the business and whether they are qualified to do so.
There are a plethora or situations and combinations of personalities and circumstances that may arise if the family is going to continue the business and, interestingly, this is one of the basic plots of movies and television programs—in particular, TV "soap" operas.
While the best chance for business success occurs if the person in charge is the person who has the appropriate skills, relationships in a family business often take precedence over good business decisions, particularly where there are numerous heirs.
Then the major problem becomes the compensation for non-active heirs. If the business is small, then the problem is exacerbated as there usually is insufficient funds to both run the business and at the same time, pay for other's share of the inheritance. Small businesses, in particular, rarely can survive a family feud and still continue a profitable business.
When there is a spouse and minor children as owners of a business, then new questions arise as whether the surviving spouse wants to continue the business. If the spouse does not want to run the business, is there a trusted employee that can run the business for the spouse and minor heirs. Of should the business just be sold?
There is also the possibility that the owner may have had only adult heirs, maybe not even family members, in which the case the questions must be asked again, but without the possible "family" reason to keep the business going.
Conclusion: Often, a sole proprietorship is successful largely because of the proprietor and customers were drawn to the unique personality of that business owner and no matter who the heirs are or how talented they are, the business may decline simply because a popular proprietor is no longer there.
In every scenario described previously (with the exception of failure because a specific person is absent), the overriding problem is related to cash. With the proprietor gone, will the business be able to generate enough cash to ensure the financial soundness of the business and the income needs of the heirs? For too many small businesses, unfortunately, the answer is "no," unless the proprietor has planned carefully in advance for the eventuality of his or her death. Sadly, many sole proprietorships are unable to continue successfully after the death of the proprietor simply because the proprietor failed to plan adequately.
Once again, a properly written Will and sufficient life insurance are the keys to:
As indicated earlier, the Will is vitally important when the business is to be continued because it clarifies who the proprietor intends to inherit and operate the business and what arrangements the proprietor made to see that the transition occurs. Legally formalizing these arrangements helps avoid many of the problems that could otherwise arise. Informally, any heir could attempt to continue the business, but from a legal standpoint, no right exists for an heir to do so unless the proprietor's Will so specify.
Furthermore, because there is no differentiation between a proprietor and the business, an heir who takes over the business during estate administration is responsible for all of the business liabilities. At the same time, any profits being generated must be included in the estate for the benefit of all heirs. This is just one of the problems that can occur if heirs continue the business when there is no Will providing the legal authority to do so.
One way a proprietor can use a Will and life insurance policies to provide for continuation of the business is by establishing-with the help of an attorney—an irrevocable trust and placing the policies on the proprietor's life into that trust. When the proprietor dies, the trust provides cash for the heirs and generally keeps the proceeds out of the insured's estate.
An irrevocable trust is one that is set up so the person establishing it, the grantor, has no right to change the terms of the trust, to benefit from it personally or to terminate it. By surrendering control of property in the trust, the grantor helps ensure that the value of the trust property (life insurance proceeds in this case) will escape inclusion in the estate.
Any type of trust, which is a legal entity created under the laws of a certain state, involves three parties:
1. The grantor, who establishes and funds the trust.
2. The trustee, who manages and administers the trust.
3. The beneficiary, who receives the funds and its benefits
As the grantor, a proprietor may place policies on his or her life into the trust, naming one or more heirs as beneficiaries. The grantor must not have any "Incidents of Ownership" within three years of his or her death in order to keep the trust's insurance proceeds out of the estate, following the same rules described previously. The trust, not the insured, owns the policies and the insured may not retain any rights associated with the policies.
In order to keep the value of trust property, called the trust corpus from being included in the insured's estate, the trust must be established while the insured is living. This type of trust is called an inter vivos or living trust, as contrasted with a testamentary trust, which is dictated by the person's Will and established only upon the individual's death. A testamentary trust does not work for the purposes we re considering because, since the trust doesn't exist until the proprietor dies, the proprietor controls the property that will eventually make up the corpus. This control subjects any life insurance proceeds in a testamentary trust to the "incidents of ownership prohibition.
Under an irrevocable living trust, the trustee holds the policies until the proprietor dies, then pays the funds to heirs according to the Will and the trust agreement. These funds may then be used for whatever expenses occur in connection with continuing the business. To avoid inadvertently including the life insurance proceeds in the proprietor's estate, the agreement must be written so there is no requirement that the proceeds be used to pay estate taxes or debts. Under current law, the trust beneficiary may, however, lend the proceeds to the estate to pay these costs without causing the proceeds to be included in the estate.
Placing life insurance policies in such a trust is another safeguard to ensure the proceeds are available when the insured business owner dies. Since the trust owns the policies, the insured avoids incidents of ownership and possible inclusion in the estate valuation. In addition, if a family member, for example, owned the policies, he might be tempted to borrow from the policies or cash them in for their surrender value in the event of economic hardship. As a result, the policies would not be available for their original purpose of continuing the business and providing cash for survivors when the insured dies. The irrevocable trust eliminates the possibility that the life insurance policies will be used for purposes other than originally intended.
It was discussed previously, the prospects of selling the proprietorship to a willing buyer, rather than having the business continue under the direction of an heir. This may be the best option from the standpoint of the proprietor's heirs, but the question then becomes, "Who will buy the business and at what price?"
Remember that the estate's administrator is required by law to close the estate as quickly as possible. If there are debts to be paid, the administrator must use whatever assets are available to close the estate including, if necessary, the assets that make a business attractive to a buyer. If a business sold quickly and at a fair price, the problem maybe solved: debts are paid and the survivors receive immediate financial relief for their income needs.
However, that's a really big “if” as he commercial classified ads in a big city newspaper shows numerous small businesses are on the market at any given time, and often for a very long time. All too frequently, the sale of a small business following the owner's death occurs under pressure to pay bills, close the estate and provide funds for the survivors. A forced sale often results in the business being sold for considerably less than it is worth and less than the survivors had reason to expect from a formerly thriving enterprise.
Instead of offering the business for sale on the open market, however, perhaps the survivors know that a capable employee is interested in owning the business. A successful proprietorship may employ one or more people who have the business knowledge, management skills, willingness and desire to carry on the business in the owner's absence. Such an employee is a prime candidate for buying and successfully continuing the business when a proprietor dies and the employee has the funds to act quickly.
Another possibility is that a family member who will not inherit the business wants to purchase it. For example, suppose Amelia, the sole proprietor, has three children, Shannon, Keenan and Bryan. Shannon works actively in the business with her mother, while Keenan and Bryan are employed elsewhere and have no interest in running the business. Rather than leaving the business to three children (or to none of the children), Amelia could arrange in advance for Shannon to purchase the business and for all three children to share in the value of the estate after Shannon has purchased the business.
The purchasing family member, of course, need not be a child or other direct descendant of the proprietor. For example, Amelia's brother, a cousin, or some other family member might be interested in owning the business. In any case, having the necessary cash to buy the business when the proprietor dies is the key element.
Still another potential purchaser is a competitor. Assuming the sole proprietor operates, near a major university, a small bookstore that deals primarily in rare literary classics, with a smattering of related book titles. Across the campus is a friendly competitor who offers a broader range of titles.
The competitor, however, would be interested in taking over the proprietor's business if the occasion should arise. This type of sale following the proprietor's death could also be arranged, again if the competitor has the funds available at the right time.
In the case of a sole proprietorship, sale to an employee who knows the business may be the best alternative for everyone when the sale is planned in advance and funded by life insurance. The employee is assured of continuing employment in a business he or she knows and now owns and the heirs are assured of receiving a fair price for the deceased proprietor’s business interest.
To make it happen, the Will, the buy-sell agreement and the life insurance policy must be in place as we’ve been emphasizing. All documents must be prepared by competent experts, the attorney, the tax accountant and the agent, naming the purchaser and describing exactly how the sale will occur if the proprietor dies.
An employee, who is the potential buyer, whether or not the employee is a family member, has more security about his or her future in the event the proprietor dies. Working for a business form the perspective of eventually becoming the owner gives the individual not only a sense of financial security, but also increased loyalty, purpose and determination to make the business profitable. The same would be true for any family member who hopes to own the business one-day. Even a friendly competitor would be encouraged to take an interest in and informally promote the business that he or she might someday purchase. Whoever the buyer is, a funded buy-sell agreement guarantees that individual will have the opportunity to buy the business.
A problem that sometimes arises when a proprietorship buy-sell agreement involves an employee is whether or not the employee can afford to pay the life insurance premiums. Sole proprietors who sincerely want the employee to be able to buy the business can help the employee in one of several different ways. One way is to increase the employee’s annual salary to match the annual premium. In this case, the employee must pay current income taxes on the increased salary, but may not take a tax deduction for paying the insurance premiums. The insurance death proceeds then escape federal income taxation, so many employees will agree to this arrangement. However, some employees may feel their income level is not great enough to take on the additional tax burden without an immediate benefit.
Another method is for the proprietor to lend the amount of the insurance premiums to the employee. However, there are no particular tax benefits to either party under a loan arrangement and, in fact; a loan can complicate the tax situations for both parties.
A popular arrangement that provides benefits for both the proprietor and the employee is split dollar insurance (discussed in detail later), but the basic method of how split dollar insurance can fund a buy sell agreement between a proprietor and an employee is as follows:
A life insurance policy is written with the proprietor as the insured and the employee as the beneficiary. Both parties “split” all of the dollars involved. Each person pays a portion of the premiums and shares in the benefits because the employee, as beneficiary, assigns part of the death benefit to the proprietor's estate. Generally, the estate will receive insurance proceeds equal to the amount of premiums the proprietor has paid and the balance goes to the employee to purchase the business.
The sale of a proprietorship results in income tax and federal estate tax consequences as discussed earlier. Taxation becomes more complicated when the form of business ownership is a partnership or a corporation.
When a general partner dies, the immediate cash needs that arise are basically: Final expenses; Estate administration expenses; and, Living expenses for survivors.
In addition, because at least one other business owner is involved in a partnership, the deceased partner's share of the business must be disposed of for the benefit of both the deceased person's heirs and the remaining partner or partners. Remember that we are discussing only general partners in this section since in a limited partnership arrangement; the death of a limited partner has no particular effect on the partnership itself. On the other hand—as discussed earlier—the death (or other departure) of a general partner legally dissolves the partnership. Under certain circumstances, however, the surviving partners may arrange to reorganize and continue the business. First, though, certain legal requirements must be met when a partner dies.
Unless an agreement to the contrary is prepared in advance of death to deal with a deceased partner's interest in the business, any surviving partners become, by law, so-called liquidating trustees of the partnership. As liquidating trustees, the partners are required to perform a number of duties to close out the business. These duties include collecting accounts receivable, paying all partnership obligations, completing any transactions in progress at the time of the death, selling partnership assets and splitting all proceeds proportionately among surviving partners and the deceased partner's estate or heirs.
Obviously, if surviving partners want to continue the business, liquidation under these circumstances isn't favorable. First of all, the business cannot be continued if assets are sold. Secondly, you've learned that forced liquidation generally results in a considerably smaller return than a sale that occurs under unpressured circumstances. Thus, even if the surviving partners are willing to liquidate and start over, it is possible they will have little capital from the liquidation proceedings to do so. Likewise, the heirs of the deceased partner may inherit considerably less than they had expected. However, if the partners have the foresight to agree in advance what will happen when a partner dies, forced liquidation can legally be avoided.
Even though the existing partnership is legally dissolved when one partner dies, the surviving partners may reorganize the partnership while continuing to operate the business. Unless a pre-existing legal agreement defines the terms under which reorganization will occur, problems can arise.
Similar to a proprietorship, a question to be answered is “Who will actively work in the business?" Heirs of the deceased partner who did not previously work in the business are not good candidates. Even if the heirs are interested in becoming partners, they might not have the needed experience or skills to replace the deceased partner. Furthermore, the surviving partners might not want the heirs to take their deceased partner's place.
Another possibility is that the heirs might choose to sell the deceased person's interest to another party who would then become a partner. Whether or not such a buyer has the necessary expertise, the surviving partners might not want an "outsider as a partner. The optimum choice is generally for the surviving partners to purchase the deceased partner's interest from his or her heirs. Control of the business then remains with the reorganized partnership. The heirs receive a fair price for their share, and the partners have the option of accepting new partners of their choice or simply continuing in business with one less partner.
A buy-sell agreement funded by life insurance is again the guaranteed solution to business continuation when a partner dies. The same basic principles involved in ensuring a smooth and efficient transfer of abusiness from one party to another when an owner dies are critical to a successful partnership buyout:
By law, a partnership is a business entity separate from its owners even though the partnership acts as a conduit through which business income flows to each individual partner. Because a partnership is a separate entity (unlike a proprietorship), partners may select one of two basic forms of buy-sell arrangements.
Under a cross-purchase arrangement, the partnership entity itself is not a party to the agreement. Instead, each partner agrees with every other partner to buy out the interest of any partner who dies. When a cross-purchase agreement is funded by life insurance, each partner purchases a life insurance policy on the life of every other partner. If a partner dies, the life insurance proceeds are paid from each individual policy to the partner who owns that policy. In turn, the surviving partner uses the proceeds to purchase part of the deceased person's interest in the business. For example, if there are two partners, the surviving partner purchases the entire interest of the deceased. If there are three or more partners, each of the survivors purchases a proportion of the deceased person's interest as agreed upon in the buy-sell contract.
The previous discussion assumes each partner owns an equal share of the business, but this is not always the case. Suppose Marlowe and Norman originates a two-person partnership, each owning 50% of the business. Several years later they decide to take on a third partner, Oliver, who purchases 10% of the existing business interest, with Marlowe and Norman now owning 45% each instead of 50% each.
Various buy-sell arrangements are possible. For example, if Marlowe, who is a 45% owner, dies, the agreement could stipulate that Norman, the other 45% owner, will purchase 30% resulting in 75% ownership after the death) and Oliver, the 10% owner, will purchase 15% (resulting In 25% ownership).
Or, each surviving partner might purchase 22.5%, resulting in 67.5% and 32.5% ownership respectively.
And another possibility: If Oliver, the 10% owner, dies, each survivor might purchase half of Oliver's interest, again restoring the 50-50 ownership.
The amount of insurance on each partner's life would be adjusted to meet the requirements of the buy-sell agreement, both originally and when additional insurance is purchased following the death of a partner.
Another approach is an entity purchase buy-sell agreement, under which the partnership entity, not the individual partners, agrees to buy a deceased partner's interest. In this case, the partnership purchases policies on the lives of each partner and the proceeds are paid to the partnership business when death occurs. The partnership is then bound to purchase the interest from the deceased person's heirs and, of course, the heirs are obligated to sell at the agreed upon price. An entity purchase arrangement can be less cumbersome when there are many partners, requiring numerous individual policies. But aside from sheer numbers, an entity purchase plan might be selected simply because that is the form the partners prefer.
This is a market for additional life insurance policies covering each surviving partner. Once again, an agent who has stayed current with this partnership is in a position to sell the additional insurance.
An insurance concept sometimes used for buy-sell agreements-for either partnerships or corporations-where there are several owners is a first-to-die policy that covers all owners under the same policy. The life insurance proceeds are paid upon the first death. Surviving partners then have the option to replace the policy with another first-to-die policy covering the survivors, without requiring medical exams or proof of insurability. In addition to forgoing medical underwriting, such policies offer the convenience of dealing with just one policy and generally lower premiums than are required for individual policies. Typically, the business entity owns the policy and pays the premiums and then uses the proceeds to purchase the deceased owner's share as described above.
Premiums paid for life insurance to fund a buy-sell agreement are not tax deductible, whether paid by the individual partners or by the partnership entity. You'll recall that this is true for buy-sell agreements initiated for the purchase of proprietorships. However, many of the same tax advantages also apply when the death proceeds are paid to fund the purchase.
One of the major advantages of using life insurance (in addition to the guarantee that funds will be available when needed) is that proceeds are generally income tax free to the beneficiaries, the surviving partners or the partnership as the case may be. Death proceeds lose this tax exemption only by violation of the transfer for value rule. Unlike situations involving family members, where buying or selling a policy can cause loss of tax-exemption, however, partnership principals may freely transfer policies to and from other partners or the partnership. This exception to the transfer for value rule, benefitting partnerships, is specifically provided in the tax law.
Life insurance proceeds are not income tax free if the IRS determines they do not pass one of the "tests" for life insurance according to the Internal Revenue Code definition. The primary consideration is that if benefits paid from a policy do not qualify under the tests as life insurance proceeds, they will be taxed as investment income instead of being received tax-free.
A partnership is automatically terminated when 50% or more of a partnership interest is transferred in a 12-month period, and some unfavorable tax consequences can result. However, when a partner's interest is transferred to one or more surviving partners because of death, the partnership is not considered to be terminated as long as some form of payment is made to transfer the interest from the deceased to the partnership or individual partners. Even if there are just two partners, each owning 50% or one owning more than 50%, no termination occurs when these requirements are fulfilled.
The death of a partner closes the partnership's tax year for that partner. Generally it does not close the partnership's tax year for the remaining partners. The deceased partner's share to be distributed must be calculated as if the partnership' tax year ended on the date the partner died/.To avoid an interim closing of the books of the partnership, the partners can agree to estimate the decedent's distributive share by prorating the amounts the partner would have included for the entire partnership tax year
A partnership's tax year closes with respect to a partner whose entire interest in the partnership is terminated by death. Therefore the partnership income must be allocated between and reported by the decedent and the decedent's successor in interest. The final individual income tax return should include the decedent's share of partnership income and deductions for the partnership's tax year that ends within or with the decedent's last tax year (the year ending on the date of death), and the final return must also include income for the period between the end of the partnership's last tax year and the date of death. The income for the partnership's tax year after the partner's death is reported by the estate or other person who has acquired the interest in the partnership.
There are several methods available that ensures the immediate transfer of the partnership interest to the spouse upon the partner's death. This can be rather complicated and expert tax advice is needed.
Prior to 2001 Tax Act, the stepped-up basis of property acquired from the deceased, there is no taxable gain (or loss) for those acquiring the partnership interest and the basis of the surviving partner or partners would have been. However, the 2001 Tax Act provided that the step-up in basis rules are to be replaced with a carryover basis system in 2010. As of this date (2008) the carryover basis rules had yet to be determined by Congress.
The alternate valuation date is the earlier of the date 6 months after death and the date on which the estate's assets are distributed, sold, exchanged, or disposed of. Alternate valuation can be elected only if it is necessary to file an estate tax return. But when the alternate valuation date is used, it must result in a decrease of the estate tax. The election is required for all property that is included in the estate and includes only property that is not sold, distributed, or otherwise disposed of within 6 months after the decedent's death.
Choosing an alternate valuation date may help to reduce the estate tax if the market value of the assets in the estate is declining. But, if the value of the assets is so declining, then the tax basis of those assets must also be reduce, which means that the income taxes in the future will be increased if the market value of the assets rises and they are than sold. Therefore, any decision to use the alternate valuation date to reduce estate tax should be balanced against a possible increase in future income taxes.
Income Tax Consequences of the Buyout for the Estate
The deceased partner's estate itself is subject to income taxation on the sale of the partner's interest, though adjustments could occur to the basis of the partnership's property—such as adopting an alternate valuation date.
One of the best ways to save tax dollars is to generate long-term capital gains, which are profits that the business makes from the sale of assets, such as stocks, bonds and real estate. However, in order to qualify for long-term capital gains, the capital asset must be held for more than one year.
Under the (recent) tax law, the top tax rate applicable to most long-term capital gains is 15% (unless the taxpayer are in the 10%-15% income tax bracket, then it is 5%), such rates applicable through 2010. The net capital gain equals the net long-term capital gains less net-short-term capital losses, A 28% rate applies to collectibles held over 12 months, a 25% rate applies to real estate gains to the extent of depreciation. The short term capital gains tax and ordinary income tax is 35%.
When the partnership entity purchases the deceased partner's interest, income to the estate is taxed according to IRS rules for the liquidation rather than the sale-of a partner's interest. The primary difference between liquidation and a sale concerns how the value of goodwill is treated. (See the next section for taxation on the basis of a sale.) In recent years, the value of goodwill was typically treated as ordinary income unless the buy-sell agreement stipulated treatment as a capital asset, in which case the liquidation payments to the estate would be subject to capital gains taxation.
As stated above, capital gains are profits from the sale of capital assets. The advantage of capital gains taxation is that taxpayers may deduct any capital losses from capital gains for the year and report only the excess, if any, as income, potentially reducing the amount of taxable income. This excess income is then included in gross income and taxed at an individual's regular marginal tax rate. In the case of a buyout because of a partner's death, the rate would be the estate's income tax rate. The point is, if the value of goodwill included in the purchase price is treated as capital, the estate may benefit from offsetting capital losses, just as an individual may so benefit, rather than having the entire amount fully taxed as ordinary income.
On the other hand, from the partnership's point of view, treating the amount paid for goodwill as ordinary income allows the partnership to take a tax deduction for that amount. So, while capital gains treatment has the potential to benefit the estate, ordinary income treatment has the potential to benefit the partnership. The partners themselves could decide which choice to make and incorporate that decision in a written agreement, such as the original partnership articles or the buy-sell agreement. (Time for legal or accounting professional help again.)
The determination as to whether goodwill is to be considered as ordinary income, and the taxing of income from personal services is from fees, commissions or other types of compensation is presently complex and is in changing. Any discussion at this time could be erroneous, at least until tax year 2010 and the new (?) Congress addresses the confusion. These laws are of interest to life insurance agents, but practically speaking, some of the changes, regardless of magnitude to the taxpaying public, require tax expertise from professionals.
When a cross-purchase buy-sell agreement is used, under which each individual partner purchases the deceased partner's business interest, the transaction is treated as a sale, rather than liquidation. While the rules are similar to those for liquidation, the tax code provides that the entire transaction must be treated as a capital transaction. This means there is no option to treat as ordinary income any portion of the purchase price that is allocated to goodwill.
Remember that life insurance policy proceeds used to fund buy-sell agreements can also escape federal estate taxation in the deceased person's estate, provided:
While life insurance proceeds are not included in the estate as long as these requirements are met, the value of the deceased partner's business interest is included. As a result, because life insurance proceeds paid to the partnership increase the partnership's value, a part of the proceeds could be included unless:
1. The buy-sell agreement specifically excludes the proceeds and
2.The buy-sell agreement establishes valuation for estate tax purposes.
Under the cross-purchase type of buy-sell agreement, the partner who dies still owns life insurance policies on the lives of the now surviving partners. Actually, the value of those policies is included in the deceased person's estate. Typically, the buy-sell agreement should give the surviving partners the option to purchase the policies on their own lives, usually for an amount equal to the cash values in the policies. The benefit to the partners is acquiring insurance coverage for premiums determined at their younger ages and without now having to prove they are still insurable. Because there is an exception for sales of policies to the insureds themselves, the transfer for value rule discussed previously is not a problem. That is, the policy proceeds do not lose their tax-exempt nature because the policy is sold or transferred as long as the policy is sold to the insured person.
Alternatively, suppose there are two surviving partners. Each of the survivors may purchase from the estate the policy on the other partner's life, again without losing the tax exemption for the proceeds. This is true because the transfer for value rule makes another exception for policies sold or transferred to the insured's partner or the partnership. Thus, if the partners decided to change from a cross-purchase plan to an entity plan, the partnership entity could also purchase the policies from the estate without a transfer for value problem.
As indicated elsewhere, the corporations most likely to be receptive to discussing business continuation insurance are closely held. Closely held corporations can be either C or S types and may include professional or personal service corporations. In addition, many such corporations are owned by various members of the same family, although this is not necessarily the case. And, in the case of S corporations, the businesses often operate more like partnerships than corporations. In many cases, one significant owner holds the majority of the stock in a closely held corporation: in others, there are just a few stockholders, with perhaps as few as two owning most of the stock.
As a result, the death of a single stockholder can have a negative effect on the business as potentially devastating as the death of a proprietor or a partner even though the corporation, unlike a proprietorship or partnership, does not cease to exist legally. Unlike a large public corporation, for example, a close corporation usually:
When a closely held corporation stockholder dies, therefore, the immediate cash needs and problems associated with continuing the corporation are nearly identical to those of incorporated businesses:
All of these needs and potential problems have been discussed in connection with proprietorships and partnerships. The separate nature of a corporation, however, means some additional concerns must be considered and planned for in advance in order to provide for fair and equitable treatment of stockholders who are actively working in the business and heirs who are either inactive stockholders or non-stockholders.
The answer, of course, lies in the stockholder's Will, a buy-sell agreement and insurance to fund the purchase of the corporate stock when a stockholder dies.
The advantages of using a buy-sell agreement funded by life insurance are generally the same for close corporations as for other business types. Some of the tax factors inherent in incorporated businesses do play a role and will be discussed thoroughly. For the most part, though, such an agreement assures the money will be available to purchase the deceased person's stock, benefitting both the business and the heirs, all parties are bound by the terms of the agreement and the value of the business may be fixed for estate tax purposes.
Under a cross-purchase stock buyout agreement, each stockholder agrees to purchase the stock of any other stockholder who dies. The surviving stockholders are obligated to buy and the heirs and/or estate are obligated to sell at the price (or based on the method of valuation) stipulated in the agreement. Each stockholder owns and pays the premiums for a life insurance policy on the life of every other stockholder. When a stockholder dies, the policy proceeds are paid to each surviving stockholder, who then uses the funds to purchase the deceased person's stock.
In some cases, the owners might prefer a cross-purchase plan to an entity plan even when there are many stockholders. To avoid dealing with many individual life insurance policies, a trust can be established to own the policies. The trustee buys and owns the policies, but the stockholders actually pay the premiums by first contributing them to the trust. The trust is then the beneficiary of the life insurance proceeds, but is, of course, obligated to use the proceeds to execute the buyout according to the terms of the buy-sell agreement.
Caution is in order concerning such trusts because of recent tax memoranda addressing this very issue. Care must be exercised in establishing the trust to be certain that stockholders do not retain any incidents of life insurance ownership, nor have any right for the trust to revert to them. This appears to be a sticky issue for buy-sell agreements funded with life insurance policies that might conceivably be returned to stockholders after other stockholders die. Another situation where it should be mandatory for a client who is considering a trust arrangement to consult with tax and legal counsel first.
The stock redemption type of buy-sell agreement is equivalent to an entity purchase agreement because the corporation, rather than the individual surviving stockholders is the party that agrees to purchase or redeem the deceased person's stock. While this type of agreement, funded by life insurance, is more convenient when there are many stockholders, it does pose some unique tax considerations, as you'll soon see. As a result, some corporations may choose the cross-purchase plan, even when it must include a large number of individual life insurance policies. Alternately, the corporation might fund the agreement with a first-to-die policy.
Premiums paid by either the corporation or individual stockholders for the insurance to fund the agreement are not tax deductible. While a corporation that benefits directly or indirectly from the policy would be disqualified from taking the deduction in any event, there is another factor that precludes the deduction for a corporation. Businesses may deduct only ordinary and necessary business expenses. Life insurance premium payments to fund buy-sell agreements do not represent such expenses, instead being considered a capital expense, expensemade to acquire an asset, which in this case is the stock. This rule applies whether the premiums are paid by the corporation itself or by the stockholders.
Generally speaking, premiums paid for insurance to fund buy-sell agreements are not considered taxable income for the owners unless the policy proceeds will be paid directly to the owner's estate or other beneficiary the insured personally selected (such as a spouse, children or other heir). However, even when a personal beneficiary is named, if that beneficiary is obligated to sell the stock in order to receive the proceeds, the premiums are not taxable as income.
On the other hand, the IRS has ruled that such premiums represent dividends in the case of close corporation. Characterized as dividends, then, the premiums are taxable income to the stockholders. If the corporation pays the premiums but the stockholders own the policies, the premiums are taxed as dividends.
Although Scorporations are generally subject to the same rules, when the premium is considered to be a distribution of profits as a dividend; taxation follows different paths depending on whether or not the corporation has accumulated earnings—earnings in excess of requirements to meet "reasonable needs of the business."
Sometimes S corporations that were formerly C corporations have such earnings from previous years. If an S corporation does have previous accumulated earnings, it's possible that all or part of the premium will be treated as a dividend and taxed as current income. Whether or not that occurs depends on the specific circumstances.
However, if the S corporation does not have accumulated earnings from previous years, the premium is treated partly as a return of the stockholder's investment and partly as capital gain, the exact proportions depending on the particular situation. The precise details of how taxation is determined is beyond the scope of this text, but you can see that S corporation taxation is even more complex than corporate taxation in general.
Life Insurance proceeds paid to fund corporate buy-sell agreement are, in general, income tax free to the beneficiaries as long as all IRS requirements have been met. However, another factor comes into play: the possibility that life insurance cash values and/or proceeds will trigger an alternative minimum tax.
This section briefly discusses an additional tax that some taxpayers may have to pay. Simply put (as much as is possible) since the tax laws give special treatment to some kinds of income and allows special deductions and credits for some kind of expenses, the IRS has devised a way to get some of that money back into its coffers. This is done by using a minimum amount of tax through an additional tax—the alternate minimum tax (AMT).
The purpose of the AMT was to make sure that the "rich" paid at least some minimum amount of tax. Until recently, there were very few situations of taxpayers being subject to the AMT. However, the IRS giveth and the IRS taketh away…since the regular income tax rates were reduced, our legislators could not stand it unless there was a corresponding increase in the AMT.
In actuality, the AMT is a separate tax system with its own allowable deductions and exclusions, often completely different from those allowed for income tax purposes. To arrive at the AMT, the regular income tax must be calculated, then calculate the tax under the AMT system and then pay the greater of the two amounts. Some (just some) of the more common items that are treated differently under the two tax systems that can affect the AMT amount:
Sharp eyes may have already noticed that one of the differences relates to the State, local income, sales and real estate taxes —they are allowable as a deduction against your income for regular tax purposes but not for the AMT. As an example that illustrates the difference (without going into all the specifics) would be where a typical family with 2 children and with gross wages of $250,000. Further assume that their local income and real estate taxes was $22,500 and mortgage interest of $20,000. If they have no interest, dividend, or capital gain income, in 2002 their federal income tax would have been $52,933, but not subject to the AMT because that calculation was only $52,780.
Now (2007) arrives, and assume that all income and deductions remain constant, and with no inflation adjustments, their regular income tax would be $44,223. However, their AMT will be $53,900—$9,677 more than their regular tax amount. That's the way it is, even though their regular tax rates have decreased.
There are many little items that can affect the AMT; such as if part of an investment portfolio consists of municipal bond holdings—oh, oh! Private activity bond interest is an item that can make it more likely that the taxpayer can be subject to the AMT. This means, in actual practice, even though one can earn higher interest on private activity bonds than other municipals, if the taxpayer is subject to the AMT, the effective yield will be slashed. If a person invests in various types of bonds, they MUST contact their tax advisor.
Long-term capital gains and qualifying dividends as subject to the same maximum rate (15%) for AMT calculations as they are for regular tax purposes. But since these items are included in the AMTI, which could reduce the allowable exemption, so the actual marginal rate could be as high as 22%. The lesson here is that prior to investing in securities that generate this type of income, the AMT must be taken into consideration.
Without going into lengthy detail, in the example above, if long-term capital gain of $100,000 is added to their $250,000 income, one might expect that the additional tax burden under AMT would be $22,000. However, if these folks lived in a state that had an 8% tax rate, the amount of taxes due on the $100,000 would be $30,000.
Generalities again, but to get a feel for this tax, the taxpayer may have to pay the alternative minimum tax if the taxable income for regular tax purposes, combined with certain adjustments and tax preference items, is more than $45,000 for married filing joint return (or qualifying widower) with dependent child; $33,750 if single or head of household; or $22,500 if married filing a separate return.
As indicated in discussions of taxes of various kinds, Congress continues to reenact temporary measures that consistently raised the applicable exemption amounts above the 2000 level. At this particular time, the last temporary increase expired at the end of 2007. The new rules are as shown below. For further information the publication is available on www.irs.gov , Publication 553 (4/2008).
The basic rule is still:
Individuals, trusts and estates must pay the alternative minimum tax (AMT) if it exceeds their regular tax liability for the year.
The following changes to the AMT went into effect for 2007. For more information, see Form 6251, Alternative Minimum Tax—Individuals, and its instructions.
AMT exemption amount increased. The AMT exemption amount has increased to $44,350 ($66,250 if married filing jointly or qualifying widow(er); $33,125 if married filing separately).
AMT exemption amount for a child increased. The AMT exemption amount for a child under age 18 has increased to $6,300.
Hurricane Katrina additional exemption expired. The additional exemption for taxpayers who provide housing for a person displaced by Hurricane Katrina has expired. Therefore, the additional exemption amount (formerly line 6 of Form 8914) is no longer allowable for the AMT.
Deduction for qualified mortgage insurance premiums allowed for the AMT. In most cases, no AMT adjustment is required for the deduction of qualified mortgage insurance premiums.
Foreign Earned Income Tax Worksheet revised. The Foreign Earned Income Tax Worksheet in the Form 6251 instructions has been revised to reflect changes made by the Tax Technical Corrections Act of 2007.
Certain credits still allowed against AMT. The special rule that allows the credit for child and dependent care expenses, credit for the elderly or the disabled, education credits, residential energy credits, mortgage interest credit, and the District of Columbia first-time homebuyer credit to be applied against the AMT was scheduled to expire at the end of 2006. However, Congress has extended the special rule through 2007, so those credits can be applied against the AMT for 2007.
Again, while this is obviously of importance to many businesses and business-persons, this is so complicated and so susceptible to changes, that further discussion is of little value. Even though the IRS information can be obtained on the Internet, it is so complicated that even the small part that applies to life insurance is complex.
For corporations, the presence of corporate owned life insurance policies-such as those used to fund a stock redemption buy-sell agreement-adds to the possibility that the corporation will have to pay the AMT. The reason is that one of the tax preference items involves the corporation's so-called book income shown on its financial statement, which will include certain values of life insurance policies. The next paragraph explains when and how life insurance policies play a role in the AMT. Remember, though, that corporate owned life insurance policies alone do not trigger the tax; they are just one of many factors that can contribute to the requirement to calculate AMTI.
In determining AMTI, C corporations (but not S corporations or individuals) must perform an adjustment to regular income to show adjusted current earnings (ACE). This is another complicated item that we will not discuss in detail, instead focusing on the role of corporate owned life insurance. The tax code requires the ACE calculation to include the inside buildup (cash values) of life insurance policies and the death proceeds in certain cases. Therefore, corporate owned life insurance policies can contribute to the AMT problem when:
1. The annual increase in a policy's cash value is greater than that year's premium.
2. The amount of death benefits paid is greater than the policies cash value.
After a few years in force, nearly all life insurance policies sold today would result in cash value increases greater than the annual premium. And, in essentially all cases, death benefits are always far greater than a policy's cash values. As a result, life insurance policies owned by the corporation, combined with other tax preference items, have a significant potential to trigger the alternative minimum tax.
From the C corporation's point of view, the threat of triggering the alternative minimum tax might be enough reason for the owners to consider implementing a cross-purchase plan rather than a stock redemption plan. When each individual stockholder owns and is the beneficiary of the policies and the corporation is neither the owner nor the beneficiary of any life insurance policy, the AMT problem for the corporation is eliminated insofar as the life insurance is concerned. Remember, though, other factors can trigger AMT, so the stockholders should consult with their tax and accounting experts in making this decision.
Stock redemption buy-sell agreements funded by life insurance also have the potential to affect a corporation's accumulated earnings situation since the cash values of corporate owned policies can represent accumulated earnings. The amounts the corporation retains from earnings to pay premiums are also accumulated earnings. Unfortunately, the IRS and the courts have been at odds in various cases involving accumulated earnings and what constitutes a reasonable need of the business. Generally, corporations can make a valid argument that accumulating funds to pay for a stock redemption in the event of a stockholder's death falls within the guidelines of reasonable business needs. This is further bolstered by the fact that, in many states, the law requires surviving stockholders of certain professional corporations to purchase the deceased person's stock.
In general and in the absence of any clearly state across-the-board IRS rulings, a corporation can expect not to have to pay an accumulated earnings tax based on the presence of corporate owned life insurance that funds a stock redemption agreement. If additional tax rulings or new laws clearly change that position, however, the problem could be solved by using a cross-purchase agreement instead.
One of the major problems with corporate stock redemptions concerns whether the redemption will be deemed by the IRS as being the equivalent of a dividend distribution. This characterization is to be avoided because dividends are taxed doubly first to the corporation (which may take no deduction for a dividend distribution) and then to the stockholders. Therefore, the goal is for stock redemptions to receive capital gains treatment. One problem is that when a C corporation makes a payment to a shareholder (or the shareholder's estate), the IRS characterizes payments as dividends rather than as a capital sale. Fortunately, the tax code also provides some exceptions.
When the corporation redeems all of a stockholder's shares, the IRS treats this transaction as a sale, not a dividend. In the case of a deceased stockholder, this seems simple enough. However, the law provides that the corporation must redeem not only the stock the deceased (or the estate) actually owns, but also stock that is constructively owned. The provisions of the tax code that address this issue are called the constructive ownership or attribution rules.
The attribution rules apply only to stock redemption agreements. The terminology comes from the fact that stock owned by one party is, in some cases, attributed to or considered constructively owned by other related parties. For example the law attributes stock owned by a beneficiary of an estate to the estate. Suppose the deceased stockholder is Ralph, whose estate receives his shares of stock. Ralph's son Mark, who is a beneficiary of the estate, is also a stockholder in the corporation. Mark's shares of stock, therefore, are attributed to or considered owned by Ralph's estate. The result is that, even if the corporation redeems all of Ralph's shares, the law does not consider it a complete redemption because Mark's stock is attributed to the estate. And without the completely redemption status, the payment is considered a dividend, not a sale.
The situation becomes especially sticky in corporations where family members comprise most or all of the shareholders because of family attribution rules. Family attribution attributes stock owned by an individual's spouse, children, grandchildren and parents to ownership by that individual. Only these relationships cause attribution; note that there is no mention of siblings, grandparents, aunts and uncles, nieces and nephews, cousins, or In-laws.
Considering the severe problems associated with family attribution rules, it might appear there is no way to avoid having a corporate stock redemption treated as a dividend distribution in family cases. However, the law does provide various ways aroundthese rules. In general, when a stockholder'sdirectinterest is completely terminated, the family attribution rules may be waived under certain conditions, allowing the redemption to be treated as a sale. The details of these arrangements are beyond the scope of this text. In addition, remember that attribution problems can be avoided by using a cross-purchase agreement.
Section 303 of the Internal Revenue Code permits a corporation to redeem all or a portion of a decedent's stock in such a manner that it will not be taxed as a dividend. Redemption under Section 303 can provide cash for estate taxes and other expenses without the income tax consequences associated with the declaration of a dividend.
1) The value of the stock that is redeemed must be included in the gross estate of the decedent in calculating the federal estate tax.
2) For federal estate tax purposes, the value of the stock that was included in the decedent's estate must be greater than 35 percent of the adjusted gross estate. For the purpose of Section 303, adjusted gross estate is defined as the gross estate minus deductions for expenses, debts, and estate taxes.
3) There is a limit on the amount of stock that can be redeemed and still receive favorable tax treatment. This amount is equal to all estate, generation skipping and state inheritance taxes plus the funeral and administration expenses associated with the stockholder's death.
4) There is also a restriction on who can sell the stock in Section 303 redemption. The corporation must purchase the stock from the person who is responsible for paying the estate taxes and administrative expenses.
In order for a corporation to redeem shares it obviously must have funds available. A convenient method to have these funds available could be to keep the funds on hand in a corporate account.
However, there is a potential problem with this strategy called "excess retained earnings." According to IRS regulations a corporation that has more than $250,000 may have "excess retained earnings" and be subject to a penalty.
(IRS) Section 303 is a special section that could be of interest if:
1) It would be advantageous to keep control of a closely held corporation.
2) The closely held corporation's stock represents a substantial portion of the estate and it is undesirable to liquidate the business for the purpose of paying estate taxes and administration expenses.
3) A plan to provide the corporation with the capital to redeem the stock has been implemented.
Section 303 rules are complex. While the above provides an overview, careful review by a competent tax or legal advisor is necessary to determine eligibility and application of Section 303
Section 303 of the tax code provides relief for family businesses while guaranteeing that a partial stock redemption will be treated as a capital transaction (sale or exchange) rather than as a dividend. Named after the pertinent part of the code, a Section 303 redemption overrides the difficult attribution provisions and related dividend treatment we just discussed. Section 303 redemption is generally available only for smaller, closely held family businesses where the stock is a large part of the estate.
Since the estate's basis in the decedent's stock will be the stock's fair market value at the date of death (for decedent's dying before 2010) only post-death appreciation will be taxed upon the redemption and only up to the maximum long-term capital gains tax rate (generally 15% for sales and exchanges before 2009). To qualify for the Section 303 redemption, the value of all the stock of the corporation included in the decedent's gross estate must exceed 35% of the decedent's gross estate. The adjusted gross estate is the gross estate less the allowable deductions for funeral and administration expenses, debts, the family-owned business deduction, and certain losses (but before any charitable deduction or marital deduction). A qualifying redemption under Section 303 is limited in amount to the sum of the following:
Note: The advantages of sale and exchange treatment under Section 303 may be rather diminished under the tax law which taxes certain qualified dividends at the lower capital gains (as contrasted to ordinary income) rate. As long as the redemption by the estate results in qualified dividend treatment, the estate would be taxed at 15% on post-death appreciation without meeting the Section 303 requirements.
Also, an estate does not actually have to be illiquid in order to qualify for this special exemption. The estate may redeem stock up to the maximum amount referred to above, if the estate has sufficient liquid assets to take care of its expenses and taxes.
When all of these requirements are fulfilled, a partial redemption will be considered a sale and will receive capital gains tax treatment rather than being treated as a dividend. Both C and S corporations are eligible for section 303 redemptions. The primary purpose of this provision is to help small family businesses avoid involuntary liquidation or bankruptcy by virtue of needing funds to pay final expenses and taxes associated with a stockholder's death.
As discussed earlier in the discussion of Partnerships, while there was a stepped-up cost basis that must be taken into consideration prior to the 2001 Tax Act, this is no longer the case and Congress has yet to act with a promised carryover basis system by 2010, which as of 2008 had not yet been enacted.
Under a stock redemption, where the corporation makes the purchase, the other stockholders are not involved at all. As a result, no increase in cost basis is available. However, each stockholder's proportionate share of the corporation's value increases. With no complementary increase in basis, then, a later sale will result in greater taxable income (assuming the stock value increases).
On the other hand, under the S corporation structure, the stockholder's basis is increased no matter what form of buy-sell is used since the S corporation's transactions flow through to each stockholder.
There are three ways that a corporation can fund a Section 303 stock redemption plan:
The corporation could accumulate sufficient cash to redeem the stock at the death of the owner. In many cases it would take many years to save sufficient funds, while the full amount may be needed in a few months (or years), also, accumulated earnings tax may arise.
Even if the corporation could obtain a business loan at a time when corporate credit is likely to be impaired, borrowing the purchase price requires that future business income be used to repay the loan—plus interest, of course. Perhaps the surviving spouse or an adult child could lend the money to the corporation to fund the redemption, if they have access to sufficient funds. Even then, future corporate earnings would be needed to repay the corporate debt.
Life insurance can guarantee that the cash that is needed to redeem the stock will be available exactly when needed. A life insurance policy on the owner in an amount equal to the expected partial redemption is the most efficient and effective source of funds for Section 303 stock redemption purposes.
As indicated, if accumulated earnings are used to fund a partial stock redemption under Section 303, every dollar that is uses costs the corporation a full dollar. If, instead, it uses the borrowed money, the cost of the transaction is increased by the interest that the corporation must pay. For illustrative purposes, assume that it borrows the necessary funds on a 5-year note at 8% interest; then the additional cost for each borrowed dollar is $.40, bringing the cost for each dollar used to make the redemption at $1.40.
If life insurance is purchased and the purchase is made using the policy's death benefits, the aggregate premium paid for the each stock redemption dollar would be less than 50¢. There are also other benefits, such as timely providing of cash; eliminating the needs to deplete cash or borrowing; avoiding possible accumulated earnings tax problems; increasing the value of the corporation (making it easier to meet the 35% test); and to top it all off, a tax-free receipt of the death benefits.
As a general rule, if the life insurance is used to fund a 303 stock redemption, the corporation is the applicant, owner and beneficiary of the policy.
An alternative is where the proceeds of the life insurance policy are paid to a surviving spouse, who then lends the necessary funds to the corporation for the stock redemption—however; the stock redemption must qualify under Section 303. The advantage of this approach is that if the stock does not qualify for the favorable tax treatment of 303, the surviving spouse has the proceeds of the life insurance company instead of the corporation having the proceeds.
If this alternative is used and the business is a regular corporation, the business owner may want to purchase the life insurance under a split-dollar plan, which would allow the business owner to use basically corporate funds instead of personal funds, the purchase the life insurance. Also, in order to avoid paying interest or recognizing imputed income resulting from a below-market loan, the endorsement split-dollar method should be used.
In general, the federal estate tax consequences of a corporate buy-sell stock redemption or cross-purchase plan funded by life insurance are determined under the same circumstances described for partnerships as discussed earlier in this text and are under a state of flux at this time, particularly as to the amount of exemption.
Under a stock redemption plan, the payment of life insurance proceeds to the corporation may increase the value of the deceased owner's stock-and therefore the value included in the estate for estate tax purposes. This problem can be avoided if the buy-sell agreement adequately establishes the value of the stock according to the requirements discussed previously. In this case, there is no taxable gain to the estate because the purchase price will be the same as the stepped-up basis or fair market value.
Under a corporate cross-purchase buy-sell agreement, the stockholder who dies still owns life insurance policies on the lives of the surviving stockholders. Normally, the buy-sell agreement provides an option for surviving stockholders to purchase the policies on their own lives, usually for an amount equal to the cash values in the policies—when an insured partner purchases the policy, the death benefit does not lose its tax-exempt status under the transfer for value rule because of an exception.
Unlike a partnership, however, a corporation's stockholders may not purchase the policies on each other's lives without losing the tax exemption. The transfer for value rule allows this exception only for partners, not for stockholders. On the other hand, the corporation itself may purchase the policies on its stockholders' lives from the deceased person's estate without causing loss of the death benefit tax exemption.
Loss of tax exemption under the transfer for value rule can also be a problem if an existing stock redemption buy-sell agreement is changed to a cross-purchase plan. For example, suppose Zee Corporation owns policies on the owners, stockholders Allan and Beth, to fund a stock redemption buy-sell agreement. If the plan is changed to a cross-purchase agreement and Zee Corporation sells (or even gives) the policy on Allan's life to Beth and the policy on Beth's life to Allan, the death proceeds of both policies lose their tax exemption because of the transfer for value rule.
The tax exemption is not lost, however, when a cross-purchase plan is changed to a stock redemption plan. In this case, Allan may transfer his policy on Beth's life and Beth may transfer her policy on Allan's life to the corporation without losing the tax exemption. This is true because one of the exceptions in the transfer for value rule allows this transaction when the insured is an officer or shareholder of the corporation acquiring the policies.
1. For a proprietorship, a buy-sell agreement with an employee who does not have the financial resources to pay the premiums for insurance funding may be accomplished when the owner and the employee share the premiums under what type of arrangement?
A. entity purchase plan.
B. first-to-die policy.
C. key employee insurer.
D. split-dollar plan.
2. Under partnership laws, when a general partner dies and no formal provisions have been made to deal with the deceased person’s business interest, surviving partners become
A. liquidating trustees.
B. insolvent.
C. executors.
D. heirs.
3. Under what type of buy-sell agreement does the partnership itself purchase a deceased partner’s interest?
A. cross – purchase plan
B. entity purchase plan
C. stock redemption plan
D. partnership liquidity plan
4. Partners A, B, & C each own a life insurance policy on every other partner to fund a buy-sell agreement. This arrangement is known as?
A. a cross-purchase plan.
B. an entity-purchase plan.
C. a stock redemption plan.
D. a first-to-die policy plan.
5. A buy-sell agreement funded by life insurance guarantees?
A. the liquidation of a partner’s interest upon death.
B. partnership will continue after a business owner dies.
C. an audit by the IRS.
D. the partner’s heirs will gain control of the partnership upon his/her death.
6. When there are several business owners agreeing to a buy-sell agreement and use a ______ life insurance policy for funding, they can guarantee future insurability after one owner dies.
A. stock redemption
B. split-dollar
C. first-to-die
D. limited term
7. Life insurance policy proceeds used to fund a buy-sell agreement can escape federal estate taxation if:
A. proceeds are payable to the estate.
B. there are incidents of policy ownership of the insured.
C. there was a transfer of the policy for inadequate consideration.
D. they are payable to the owner’s spouse.
8. When an entity purchase buy-sell agreement is used by a corporation, the agreement is often termed a
A. testamentary agreement.
B. liquidation agreement.
C. stock redemption agreement.
D. corporate benefit.
9. If the IRS characterizes premiums paid by a close corporation on life insurance policies as dividends, the premiums are
A. exempt from taxation as a business expense.
B. deductible from taxation as a business expense
C. included in the value of the stockholders estate.
D. taxable income to the stockholder .
10. With a corporate cross purchase type of buy-sell agreement, funded by life insurance, the policies are owned by the
A. individual shareholders.
B. corporation.
C. directors.
D. beneficiary.
ANSWERS
1D 2A 3B 4A 5B 6C 7D 8C 9D 10A