Discussion:Buy/sell: owner of life insurance policies
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Discussion Forum Index --> Tax Questions --> Buy/sell: owner of life insurance policies
| 21 November 2008 | |
| I am a partner in a CPA firm organized as a two-person LLC. My partner and I have a cross-purchase buy/sell agreement and are arranging term life insurance policies on each of us to fund it in the event either of us dies. The plan is for the firm (1) to buy a policy on partner 1 and designate partner 2 as beneficiary, and (2) to buy a policy on partner 2 and designate partner 1 as beneficiary. If either partner dies, the other partner will then receive directly the proceeds of the policy on the deceased partner, and can use those proceeds to purchase his interest from the decedent's estate.
We want to set it up this way because if we add partner 3, we can then change the beneficiary designation on partner 1's policy to be split equally between partners 2 and 3, with the same adjustment to partner 2's policy. Then, we only have to secure a policy on partner 3. I have mentioned this structure to several fairly sophisticated tax planners, and everyone comments that cross-purchase buy/sells are always funded with life insurance policies owned by each partner, not by the firm. Can anyone give me a good reason why the structure I propose won't work more effectively than each partner purchasing policies outside the LLC? I can't see transfer-for-value rules affecting this, because there wouldn't be a policy transfer, and even if there was, it would be between the partnership and its partners, so it's exempt from those rules. Others have suggested that the LLC retaining the incidents of ownership might mean the proceeds, or at least half the proceeds, would be drawn into the decedent's estate, though that seems like a stretch. Any thoughts? | |
| 21 November 2008 | |
| why should the survivor (who now has all the cash fromn the life insurance policy) even want to pay ANYTHING to the deceased partner's family? What will REQUIRE him to buy out his deceased partner's share? | |
| 22 November 2008 | |
| The surviving partner is contractually bound, by the buy/sell agreement, to buy the deceased partner's membership interest. | |
| 22 November 2008 | |
| Based on Rev. Rul. 61-134, if applicable at all to LLCs, the IRS could argue that the life insurance proceeds are in fact distributions (or possibly guaranteed payments). Other than that, I think you strategy might work. | |
| 22 November 2008 | |
| Thank you, JB... your observation about 61-134 was very insightful. Even though it specifically applied to corporations, I'm not sure it's worth taking the chance, since the ruling indicates the IRS's proclivity in a situation like that. I'll have to do some research to see if any further activity has occurred on that front in the intervening 47 years.
I appreciate your comments, and am still open to other opinions if anyone has them. | |
| 22 November 2008 | |
| Dcrane, I understand that the survivor is contractually required to buy out the deceased members interest, but I have seen too many times where this didn't happen, the contract was 'lost', the business was gutted (while the survivor started a new business with the old clients), the business was run down before valuation, etc.
Thus my point. Why not have the deceased spouse/estate get the proceeds directly and walk away from the business? The contract (between the living) could specify that, couldn't it? No hard feelings then that the surviving partner cheated the deceased. As long as the insurance proceeds reflect the value of the business, that is. | |
| 22 November 2008 | |
| Thank you, Kevin, for your comments. It's an interesting idea that completely eliminates the need for the decedent's heirs to fuss with enforcement of the agreement. Seems cynical on the surface, but perhaps it's simply realistic. We'll probably stick with the buy/sell, and make sure the partners' heirs are well aware of the agreement's existence. The one benefit of the way we're structuring is the step-up in basis for the partner purchasing the decedent's interest. | |
