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IDEAS June Cross Purchase Buy-Sell for Two Business Owners: Options for Funding with Life Insurance

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IDEAS

June 2013

Cross Purchase Buy-Sell for Two Business Owners:

Options for Funding with Life Insurance

Summary

Like skinning a cat, there is more than one way to arrange life insurance funding for a cross purchase buy-sell involving two business owners. Here are pros and cons of several methods.

Related Information

Breaking the Cardinal Rule? Cross-Endorsements as an Alternative Method for Arranging Life Insurance Policies in a Cross-Purchase (10/10); Buy-Sell Agreements Funded With Life Insurance in brief (05/09)

The typical scenario, and the typical questions

Dave and Julie own an S Corporation together, 50/50. They decide that they would like to enter into a cross purchase buy-sell agreement triggered by death (among other triggers). They also decide that they’d like to fund the agreement with life insurance. But there are questions. Should they buy term or permanent? Should each own on a policy on him or herself, or on the other person’s life? Does split dollar have a role?

Before diving into those questions, it’s worthwhile to note two significant tax issues that permeate the analysis of virtually any buy-sell plan funded with life insurance.1

1. Incident of ownership – estate tax. Under § 2042, the policy’s death benefit is in the insured’s estate for estate tax purposes if he holds any incidents of ownership over the policy. This includes outright ownership of the policy, of course, but can also include the right to name a beneficiary and some other powers over the policy.

2. Transfer-for-value rule – income tax. Under § 101, life insurance death benefit is normally received income tax-free. The “transfer-for-value” rule is an unwelcome exception to the normal rule, in that it makes the death benefit income taxable if the policy – or an interest in it, such as its death benefit – is transferred for valuable consideration (basically meaning transferred for any reason other than a gift). As such, the transfer-for-value rule is generally

1 Although this article considers just a two-person cross purchase, the issues covered here are essentially the same for cross purchase plans involving more than two owners, but with everything a bit more complex as the number of owners increases. What’s more, if there are more than four or five business owners, some parties might consider yet another option not mentioned here: an “escrowed buy-sell” plan. Such an arrangement mimics having one policy per business owner, with each policy jointly owned by the non-insured business owners, but with one escrow agent acting as a nominal/conduit owner for these non-insureds. See Escrowed Buy-Sell Plan in brief (05/09).

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triggered if the recipient of the death benefit is required to use the proceeds to buy the business interest of the deceased insured.

Luckily, there are exceptions to the transfer-for-value rule that preserve the tax-free nature of the proceeds. These exceptions include transfers to (i) the insured, (ii) a partner of the insured, (iii) a partnership in which the insured is a partner, and (iv) a corporation in which the insured is an officer or shareholder. The other transfer-for-value exception is when the transferee’s basis in the policy is determined by reference to the transferor’s basis (often called the “carryover basis” exception).

With that background in mind, described below are pros and cons of the following options:

• cross-own term;

• cross-own permanent;

• cross-own term, plus permanent on self;

• insured owns permanent on self, names non-insured as beneficiary;

• insured owns permanent on self, plus endorsement to non-insured;

• spouse of insured owns permanent, plus endorsement to non-insured;

• irrevocable trust of insured owns permanent, plus endorsement to non-insured.

The various options

1. Cross-own term

Dave owns a term policy on Julie and names himself beneficiary; Julie owns a term policy on Dave and names herself beneficiary.

a. Pros:

i. Simple.

ii. No transfer-for-value problem. There won’t be any transfer of a policy or any portion of it. On each contract, the owner is also the beneficiary and both are unchanged throughout. If they do trade policies when the buy-sell ends, the “to the insured” exception of the transfer-for-value rule will be met.

iii. Smaller premium than for permanent policies. Buying term is more apt to make sense if Dave and Julie have little money to spare, or are absolutely certain that their buy-sell obligation will endure for a short time period (e.g., 5-10 years).

Term on J Dave (D) Julie (J) Term on D

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b. Cons:

i. If buy-sell obligations (and insureds) outlive the term, there is no coverage. If Julie and Dave purchase term policies that endure for, say, merely 10 years, what happens if they stay in business beyond that time? They could easily still have a buy-sell obligation, but they wouldn’t have insurance to cover it. Trying to buy new insurance years later will mean an older insured and a higher premium, and the insureds could have a health change that renders them uninsurable.

ii. Term policies won’t help with a lifetime buy-out. If the buyout obligation is triggered by an event besides death – e.g., disability or employment termination – term policies won’t contain any cash value that Julie or Dave could dip into to carry out a lifetime buyout. To some extent this evokes the often stated (and often under-thought) mantra of “buy term and invest the difference.” Even if Dave and Julie are disciplined enough to invest the entire amount by which a permanent premium exceeds a term premium – few folks truly are – the tax-deferred growth of a permanent policy’s cash value can often overtake a separate taxable investment in 10 or 15 years.2

iii. Over time, term might be more costly than permanent. Term policies are fine if the parties are certain that the buy-sell plan will terminate in just a few years, but such certainty is rare. If the buy-sell obligation lasts for 10 or 15 or more years, they might find that it’s more cost-effective to buy permanent policies (for one reason, a permanent policy’s dividends can be used to pay premiums).

iv. Insured does not control policy on self. The buy-sell agreement can require that Julie and Dave regularly pay premiums on the policy each owns on the other, and not encumber the policy in any manner. But as is true with any cross-owned policies, term or permanent, the policy on each is solely owned by the non-insured. Theoretically, then, Julie could hinder the buy-sell plan by collaterally assigning the policy insuring Dave, or by transferring it, or by not paying premiums. What’s more, once the buy-sell ends, Julie could keep the policy on Dave’s life. And Dave could do the same with the policy he has on Julie’s life.

To counter this, they might consider collaterally assigning the policy to the insured, or putting a restriction on it that prohibits a beneficiary change without the insured’s consent. But granting such power to the insured generally amounts to an incident of ownership – a downside for those concerned about the estate tax.3 Another approach might be to add a provision in the cross purchase agreement that requires

2 Of course, the cash value growth varies widely by type of policy and age of insured, but to run the numbers on this “buy term and invest the difference” scenario, you can run a life illustration in the Northwestern Mutual Network Illustration System, and in the “Output Options” section of the input screen, under “Ledger Type,” select “Perm vs Term.”

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the policyowner to offer to sell the policy to the insured when the buy-sell ends, but some legal authorities suggest that this too amounts to an incident of ownership.4 To avoid the estate inclusion risk, Dave and Julie might just hope that the other will live up to his or her legal obligations under the agreement.

2. Cross-own permanent

Dave owns a permanent policy on Julie and names himself beneficiary; Julie owns a permanent policy on Dave and names herself beneficiary.

a. Pros:

i. Simple.

ii. Cash value of permanent policy can help with a lifetime buy-out. If the buyout obligation is triggered by an event besides death – e.g., disability or employment termination – Julie or Dave could dip into cash value to carry out a lifetime buyout. Withdrawals from cash value are normally tax-free up to basis, or can be in the form of loans against the policy.5

iii. Can be used after buy-sell ends. Permanent policies are just that – permanent. So whether both Dave and Julie outlive the buy-sell arrangement, or just one of them does, any permanent policy that remains can still be used for other needs, such as estate planning or survivorship income.

b. Cons:

i. Higher premium. Permanent policies cost more than term policies (but they offer more too).

4 See, e.g., Rev. Rul. 79-46, 1979-1 C.B. 303. But see Estate of Smith v. Comm’r, 73 T.C. 307 (1979), which found no incident of ownership under similar facts, where an insured employee had the right to buy the policy from his employer if the employer was going to surrender it.

5 Borrowing against the policy really entails borrowing from the insurance company and using the policy as collateral. The loan doesn’t trigger income tax by itself. But a policyowner’s failure to repay at least the interest on the loan will cause the loan against the policy to grow (interest being added to principal). If the loan gets so large that it nearly meets gross cash value, the insurance company will lapse/surrender the policy to pay itself back, and the policyowner will be taxed on any built-in gain (although he receives little or no cash from the policy to pay this tax). This is often called a “surrender squeeze.”

Perm on J Dave (D) Perm on D CV = Cash Value P = Premiums Julie (J)

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ii. Younger healthier person pays high premium for policy insuring the older less healthy person. An “answer” to this is that it is not a bad thing – you pay more for premium on an older insured because that policy is likely to produce death benefit sooner – but that view is not often appreciated by young and healthy policyowners (or the old and unhealthy, for that matter).

iii. Trading policies at end of buy-sell triggers income tax on gain. If Dave and Julie both are alive when their buy-sell need ends (e.g., they both retire), they likely would trade policies, so that the policy that Dave owns on Julie he transfers to her, and the policy that Julie owns on Dave she transfers to him. This meets a transfer-for-value exception – each policy is going to the insured – so the death benefit remains income tax-free. But it is a “sale or exchange” that triggers income tax under § 1001 when the trade occurs.6 Each person in taxed on the value of what is received (policy plus anything else), minus the basis in the policy transferred away.

If Dave and Julie equalize the value of what is transferred – either because the

policies have equal value, or, say, the person with the lower valued policy pays extra money – then each person is income taxed on the gain that exists in the policy

he or she transfers away.

3. Cross-own term, plus permanent on self

Dave owns two policies: a term policy on Julie and names himself beneficiary; and a permanent policy on himself and names his spouse (or whomever he chooses) as beneficiary. Julie also owns two policies: a term policy on Dave and names herself beneficiary; and a permanent policy on herself and names her spouse (or whomever she chooses) as beneficiary. a. Pros:

i. For a given death benefit amount to fund the buy-sell, premiums for term policies are smaller than premiums for permanent policies.

ii. If buy-sell is triggered at death, cross-owned term policies will avoid transfer-for-value income tax problem (again, never had been transferred), and avoid estate inclusion (not owned by insured).

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It does not qualify as a tax-free § 1035 exchange because the policy relinquished by Dave (insuring Julie) doesn’t have the same insured as the policy he acquires (insuring Dave). The same goes for Julie.

Perm on D Dave (D) Term on J Julie (J) Perm on J CV = Cash Value P = Premiums Term on D

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iii. If buy-sell is triggered during life – e.g., Dave retires – Julie can dip into the cash value of the permanent policy she owns on herself to make a down payment to buy Dave’s stock. Whether Julie owns a permanent policy that insures herself or Dave (or someone else), distributions are tax-free up to basis, and policy loans are available too.

iv. As for the larger premium on permanent policies, the younger healthier insured won’t have to pay premiums on the permanent policy insuring the older unhealthy co-shareholder.

v. Permanent policies can be used after the buy-sell arrangement ends.

vi. In order for Dave and Julie to ultimately own permanent policies on their own lives at the end of the buy-sell, there is no need to trade policies and trigger income tax. b. Cons:

i. Little more complex. Dave and Julie each would buy two policies. That’s a bit more complicated than owning just one policy.

ii. Little more expensive. Buying two policies is pricier than owning just one policy. 4. Insured owns permanent on self, names non-insured co-business owner as beneficiary

Dave owns a permanent policy on himself, and simply names Julie as revocable beneficiary of much or all of the policy’s death benefit. Julie does not pay Dave for the cost of any insurance protection, nor do they account for it any other way. A mirror image of this occurs with the permanent policy that Julie owns on herself.

If Dave dies, the death benefit paid to Julie as beneficiary seemingly is tainted by the transfer-for-value rule – her valuable consideration being a promise, explicit or implicit, to use the proceeds to buy Dave’s stock. A transfer-for-value violation makes the proceeds income taxable to Julie. But if Dave and Julie can enter into a separate partnership, there’s a

Julie (J) Perm on J beneficiary is Dave Dave (D) beneficiary is Julie Perm on D

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good chance they can avoid this tax by meeting the “transfer to a partner of the insured” exception.7

As for Dave’s estate tax, he owns a policy on himself, so there’s estate inclusion for the death benefit under the “incident of ownership” rules. An estate tax deduction for the death benefit going to Julie seems unavailable here. There is some authority that such a deduction is permitted if there’s a binding endorsement split dollar agreement and the endorsee pays the policyowner the cost of insurance – see next option – but there is no endorsement or paying of an insurance cost here.8 Same goes for the policy Julie owns on herself.

a. Pros:

i. No split dollar complexity. Just a beneficiary designation.

ii. The transfer-for-value problem likely can be solved by having Dave and Julie create a partnership together. At Dave’s death, the transfer-for-value problem relating to the death benefit going to Julie should be resolved by meeting the “transfer to a partner of the insured” exception. Same is true in reverse if Julie dies.

There is, however, some ambiguity about whether the “partner of the insured” exception is available here. With a revocable beneficiary designation, some practitioners might fear that: (i) the transfer of an interest in a policy doesn’t occur until Dave’s death;9 and (ii) once Dave has died, he no longer is a “partner,”10 so that at the time of the transfer, Julie no longer holds the status of being a partner of the insured. There might be reason to dismiss this fear as purely academic,11 but for those who dislike ambiguity because it invites I.R.S. attempts to re-cast transactions in a way that increases taxes,12 they might prefer a cross-endorsement instead (see next option, number 5).

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To meet this transfer-for-value exception, they don’t need to change the tax organization of the existing S Corporation, nor do they need to have the death benefit go to the partnership itself.

8 Such was the conclusion of Private Letter Ruling 90-26-041 (March 30, 1990), where an insured policyowner endorsed death benefit to his employer and the employer paid the one-year term cost for the proceeds it controlled. 9

The law is unclear as to whether an “interest in a policy” is in fact transferred by a mere provision in the buy-sell agreement requiring Dave to name Julie as beneficiary, if that designation is revocable on the policy itself. 10 For example, a deceased partner’s successor in interest – often the dead person’s estate – generally cannot act on behalf of the partnership as an alive partner could.

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Reasons to think that the Julie should still be viewed as a “partner” of Dave despite his death include the fact that the transfer-for-value rule is only concerned with taxation of death proceeds. By necessity, then, the rule becomes relevant only once the insured is dead. Also, the transfer-for-value rule generally functions as a protection against those trying to avoid insurable interest rules by selling pre-existing policies to 3rd parties having no relationship to the insured. But the transfer-for-value exceptions recognize that partners generally have an insurable interest in each other (e.g., to carry out a buy-sell). It would be odd to deny the exception to Julie here where she’s Dave’s partner until he dies, but to permit the exception if the policy insuring Dave had been transferred to Julie while Dave’s alive and still Julie’s partner, but they then terminate their partnership several years before Dave dies. 12

For example, the I.R.S. might argue that, because no split dollar plan was in place and no accounting for cost of insurance occurred, the tax-free life insurance proceeds should be treated as if they were paid to Dave’s estate first, with a subsequent transfer of funds to Julie (how to characterize that transfer to Julie would be the question).

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iii. If buy-sell is triggered during life – e.g., Dave retires – Julie can dip into the cash value of the permanent policy she owns on herself to make a down payment to buy Dave’s stock. Same is true in reverse if Julie retires.

iv. The insured who is younger and healthier won’t have to pay premiums on the permanent policy insuring the other person who is older and less healthy.

v. Permanent policies can be used after the buy-sell arrangement ends.

vi. In order for Dave and Julie to ultimately own permanent policies on their own lives at the end of the buy-sell, there is no need to trade policies and trigger income tax. vii. Large and indexed estate tax exemption – $5.25 million in 2013 – could render

moot the fact that each insured will have the death benefit in his or her estate. Dave and Julie just might not be that wealthy.

b. Cons:

i. Death proceeds paid to other business owner are in the insured’s estate for estate tax purposes. This is a big deal if Dave or Julie is wealthy enough to attract an estate tax. An executor could have an estate tax bill on, say, a $20 million estate ($10 million value of stock plus $10 million of life insurance), but ultimately have only $10 million to pay the tax (after having sold stock to the other business owner). ii. Transfer-for-value problem if partnership not created. If Dave and Julie forget to

create the partnership, the death benefit paid to the other business owner is income taxed without any exception to the rule being met.

iii. Transfer-for-value ambiguity even if partnership is created. As explained above in the “pros,” with a revocable beneficiary designation there is the fear that: (i) the transfer of the interest in the policy doesn’t occur until the insured dies; and (ii) once the insured dies, he can no longer be viewed as a “partner,” so the survivor cannot be treated as a “partner of the insured.” Again, for those who fear this possible outcome, they might want to use cross-endorsements instead (see next option).

iv. The beneficiary has no control over the policy or its death benefit (and so might never receive it).

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5. Insured owns permanent on self, plus endorsement to non-insured (cross-endorsement)

Dave buys a permanent policy on himself, and endorses much of the policy’s death benefit to Julie through a split dollar agreement. Julie pays Dave for the cost of this endorsed insurance protection. If the buy-sell agreement terminates while Dave is still alive, Julie releases the endorsement and Dave keeps the permanent policy on himself. A mirror image of this occurs with the permanent policy that Julie buys on herself.13

If Dave dies, the endorsed death benefit paid to Julie would be taxable because the endorsement violates the transfer-for-value rule. To avoid this, Dave and Julie enter into a separate partnership, so that any transfer is to a “partner of the insured.”

As for Dave’s estate tax, he owns a policy on himself, so estate inclusion for the death benefit under “incident of ownership” rules is likely, if not certain. But the binding split dollar agreement and Julie’s payment of the cost of insurance might permit Dave’s executor an estate tax deduction for the amount of endorsed death benefit (as a deduction for mortgaged property under § 2053(a)(4)).14

a. Pros:

i. Transfer-for-value problem can be solved by creating a partnership. If the buy-sell is triggered at death – e.g., Dave dies – the transfer-for-value problem due to the endorsement to Julie is resolved by meeting the “transfer to a partner of the insured” exception. Same is true in reverse if Julie dies.

An endorsement more clearly meets the “transfer to a partner of the insured”

exception than a revocable beneficiary designation because of the timing of when the transfer occurs. An endorsement transfers a policy interest (right to name a beneficiary) currently, while the insured is alive, and while the insured is alive it is obvious that he still can be a “partner.”

13 For more details about this idea and its corresponding tax issues, see our Planning Idea, Breaking the Cardinal Rule? Cross-Endorsements as an Alternative Method for Arranging Life Insurance Policies in a Cross-Purchase,

Advanced Planning Bulletin, November 2010. Some refer to cross-endorsements as a form of “reverse split dollar,” but the rules are essentially the same as any endorsement split dollar plan

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This was the conclusion of Private Letter Ruling 90-26-041 (March 30, 1990), where an insured policyowner endorsed death benefit to his employer and the employer paid the one-year term cost for the proceeds it controlled.

Dave (D)

endorsed death benefit

Perm on

D

Julie (J)

endorsed death benefit

Perm on

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ii. If buy-sell is triggered during life – e.g., Dave retires – Julie can dip into the cash value of the permanent policy she owns on herself to make a down payment to buy Dave’s stock. Same is true in reverse if Julie retires.

iii. The insured who is younger and healthier won’t have to pay premiums on the permanent policy insuring the other person who is older and less healthy.

iv. Permanent policies can be used after the buy-sell arrangement ends.

v. In order for Dave and Julie to ultimately own permanent policies on their own lives at the end of the buy-sell, there is no need to trade policies and trigger income tax. The release of the endorsement should not trigger any income tax.

vi. Release of endorsement to insured won’t cause transfer-for-value problem. It’s not clear if a release of an endorsement is itself a transfer-for-value – it might be the mere termination of a transfer (the endorsement) rather than a new transfer – but even if it is, here it meets the exception of being transferred “to the insured.”

b. Cons:

i. Complexity. To do this properly, the parties need to enter into two split dollar endorsement agreements and annually account for the cost of insurance.

ii. Lack of certainty about estate tax deduction. The legal authority for the notion that Dave is permitted an estate tax deduction for the endorsed death benefit is found in Private Letter Ruling 90-26-041. Some attorneys might not feel comfortable relying on non-precedential guidance.

iii. Policyowner-insured is income taxed on the annual cost of insurance. The split dollar regulations state that a policyowner who receives payment for endorsed death benefit is taxed on those payments, just like a landlord is taxed on rent received.15 iv. Transfer-for-value problem if partnership not created. If Dave and Julie forget to

create the partnership, the endorsed death benefit will be income taxed to the recipient because no exception to the rule is met.

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Treas. Reg. § 1.61-22(f)(2)(ii). Having the endorsee pay for the annual cost of insurance is needed to have the situation match the facts of the private letter ruling that permitted the estate tax deduction.

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6. Spouse of insured owns permanent, plus endorsement to non-insured

This is virtually identical to the set-up described immediately above, except that Dave’s

spouse owns the policy on Dave’s life rather than he owning it himself, so that he avoids any

incident of ownership. a. Pros:

i. No estate tax problem. Because Dave does not own a life insurance policy on himself to begin with, he presumably doesn’t need to worry about whether a deduction is permitted for the death benefit endorsed to Julie. The same is true for Julie.

ii. Transfer-for-value problem can be solved by creating partnership. As in the immediately preceding situation, the transfer-for-value problem can be resolved by Dave and Julie creating a partnership together.

iii. If buy-sell is triggered during life, Dave’s spouse can dip into the cash value of the policy she owns on Julie to provide Dave the funds he needs to make a down payment to Julie for her stock.16 Julie’s spouse could do the same.

iv. The insured who is younger and healthier (or that insured’s spouse) won’t have to pay premiums on the permanent policy insuring the other person who is older and less healthy.

v. Permanent policies can be used after the buy-sell arrangement ends.

vi. In order for Dave and Julie to ultimately own permanent policies on their respective lives at the end of the buy-sell, there is no need for Dave and Julie to trade policies

and trigger income tax.

16 Transfers of money or property between spouses generally have no gift or income tax consequences.

Perm on

D

endorsed death benefit

Dave (D) Dave’s Spouse

Perm on

J

endorsed death benefit

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b. Cons:

i. Marital discord or divorce. Dave doesn’t own or control the policy on his life; his spouse does. Dave’s spouse could do things with the policy that Dave doesn’t like, and could even divorce him and potentially take the policy.17

ii. Complexity. Again, there will be two split dollar agreements with annual accounting for the cost of insurance.

iii. The policyowner (spouse of insured) is income taxed on any annual cost of insurance amount received from the endorsee.

iv. Transfer-for-value problem if partnership not created. If Dave and Julie forget to create the partnership, the endorsed death benefit will be income taxed to the recipient because no exception to the rule is met.

v. The release of an endorsement to insured’s spouse might itself be transfer-for-value. And if it is a transfer-for-value – the law is unclear – it won’t meet the “to the insured” exception because it is going to the insured’s spouse.

7. Irrevocable grantor trust of insured owns permanent, plus endorsement to non-insured

This is virtually identical to the set-up described immediately above, except that an

irrevocable grantor trust owns the policy on Dave’s life, rather than Dave owning it himself

or having his spouse own it.

This should (i) avoid the incident of ownership that would occur if Dave owned the policy himself, and (ii) also avoid any potential transfer-for-value when the endorsement is released, due to the irrevocable trust being a “grantor trust” under §§ 671-679 with respect to the insured.18

17 Of course, even if Dave himself owned the policy on his life, that doesn’t automatically shelter it from being divisible upon divorce.

18

For purposes of the transfer-for-value rule, a transfer of a policy (and presumably, an interest in it) to a grantor trust under §§ 671-679 is treated as a transfer to the individual grantor. If that individual is the insured, then the “to the insured” exception is met. Rev. Rul. 2007-13, 2007-11 I.R.B. (February 16, 2007).

endorsed death benefit

Perm on

D

Dave (D)

endorsed death benefit

Perm on

J

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a. Pros:

i. No estate tax inclusion of death benefit.

ii. Cash value of policy still could be accessed (indirectly) for lifetime buy-out. If the irrevocable trust is drafted flexibly, the trustee could take cash from the policy and distribute funds to Dave’s spouse while he is alive to help with a lifetime buy-sell. iii. Release of endorsement to irrevocable grantor trust won’t cause transfer-for-value

problem. Again, it’s not clear if a release of an endorsement is a transfer-for-value, but even if it is, here it would meet the exception of being transferred “to the insured,” as long as the trust holding the policy on Dave is a “grantor trust” with respect to the Dave. Same goes for the trust holding the policy on Julie.

iv. If buy-sell ends while the insured is alive, permanent insurance in the trust can be used for other reasons, especially for estate planning.

b. Cons:

i. Transfer-for-value problem if partnership not created. If Dave and Julie forget to create the partnership, the endorsed death benefit will be income taxed to the recipient because no exception to the rule is met.

ii. Complexity. Again, there will be two split dollar agreements with annual accounting for the cost of insurance.

iii. Each insured (as grantor of grantor trust that owns a policy) is taxed on any annual cost of insurance amount received from the endorsee.

iv. Trustee fiduciary duties. The trustee of either trust has a fiduciary duty to the trust beneficiaries, e.g., to Dave’s spouse or children, not to Dave. The trust should be drafted in a way that would make the trustee comfortable that this duty is being fulfilled even though most of the death benefit of a trust-owned policy is being endorsed to Julie, and is not coming to the trust. This could be aided by trust provisions that direct the trustee to use trust assets to facilitate transactions that could benefit the spouse and children even if they occur outside the trust (e.g., the buy-sell). It also might be aided by simply placing the endorsement on the policy

before it’s put in the trust; the trustee can only play the cards it’s dealt. Any distribution to help with a lifetime buy-out should be similarly evaluated.

Conclusion

There is more than one way to arrange life insurance policies used for a cross purchase buy-sell. Unfortunately, there is no set-up that is inherently “better” than any other. All have their pros

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and cons, and business owners should simply walk through these options with knowledgeable legal counsel and their financial representative.

This publication is not intended as legal or tax advice; nonetheless, Treasury Regulations might require the following statements. This information was compiled by the advanced planning attorneys of The Northwestern Mutual Life Insurance Company. It is intended solely for the information and education of Northwestern Mutual Financial Representatives, their customers, and the legal and tax advisors to those customers. It must not be used as a basis for legal or tax advice, and is not intended to be used and cannot be used to avoid any penalties that may be imposed on a taxpayer. Northwestern Mutual and its Financial Representatives do not give legal or tax advice. Taxpayers should seek advice regarding their particular circumstances from an independent tax advisor. Tax and other planning developments after the original date of publication may affect these discussions.

References

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