There are questions surrounding buy-sell agreements. Life insurance is a big deal in any household. Without it, you’d have to worry about your loved ones. There are many options to choose from when it comes to buying life insurance. Our experts answer some questions revolving around this topic.
Question – What should be done with existing life insurance where a corporation changes from a stock redemption to a cross purchase agreement?
Answer – In the case of a corporation that switches to a cross purchase from a stock redemption (perhaps to avoid or minimize the impact of any corporate AMT), planners should consider leaving currently owned corporate insurance on a reduced paid up basis (the cash values in the policies pay future premiums but the death benefit is reduced) and using that corporate coverage as key employee insurance. Parties to the agreement can then purchase new coverage without fear of violating the transfer for value rule.
Question – Can a trustee be used to solve the “multiple policy problem” when funding a cross purchase buy-sell?
Answer – Planners should beware of an often mentioned solution to the multiple policy problem in a cross purchase arrangement: the use of a trustee. It has been suggested that if the shareholders in a cross purchase agreement give cash to a trustee who will purchase insurance on each shareholder’s life on behalf of the others, only one policy is necessary on each shareholder’s life.
While this statement is correct, when the first shareholder dies, his estate still owns an interest in the policies he owned on the other shareholders’ lives. When that interest is transferred to the other shareholders (regardless of the form of the transfer) who have beneficial interests in the trust, the surviving shareholders now have a right to insurance proceeds they did not have before. This could easily trigger an adverse income tax consequence under the transfer for value rule.
An alternative strategy is to use a partnership to own the insurance for the cross-purchase arrangement. Upon the death of an insured partner, the death proceeds can be distributed to the remaining partners who can use the proceeds to purchase the business interest of the deceased owner. Since all the owners are partners, transfer for value should not be an issue (however, it is suggested that the partnership owning the life insurance should have a valid business purpose).
Question – Is there a simplified way to explain Code section 2703 and its implications to my clients?
Answer – Yes. In a nutshell, neither the IRS nor the courts will be bound for estate tax purposes to the price established in a buy-sell agreement unless the seller would in fact sell the interest to a totally independent nonfamily member for that price and that party (assuming reasonable knowledge of the relevant facts) would reasonably and without coercion pay that price.
Buy-sell agreements among related parties must now use an appraisal or a reasonable formula. Fixed prices set in buy-sells will probably not be accepted by the IRS or the courts as determinative of estate tax value no matter how reasonable when drafted.
Planners should review all buy-sell arrangements for compliance with the latest estate freeze rules and safe harbor requirements for buy-sell agreements. Many of these agreements should be revised to provide a more realistic price.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM