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Using Life Insurance in Closely-Held Companies

Allison J. Shoemaker, CPA
Allison J. Shoemaker, CPA Director, Tax Strategies

Using life insurance in closely held companies

It is important for individual shareholders in closely-held companies to plan for future liquidity needs, which may include funding buy-sell agreements, paying estate taxes (family succession planning), and “key man” coverage for the owner or other valuable company executives. Life insurance can be an effective way to plan for these needs.

Funding buy-sell agreements via life insurance policies can be achieved by the co-owners purchasing policies on the life of the other co-owner(s). The beneficiary of the policy must be the co-owner purchasing the policy. Upon the death of a co-owner, the beneficiary would be permitted to use the policy’s proceeds to purchase the deceased co-owner’s stock. The buy-sell agreement usually states the valuation of the stock purchase price in the agreement. One issue with the cross-insurance arrangement, however, is that the insurance premiums are paid by the co-owners personally, rather than by the company.

Another method of funding a buy-sell agreement would be to have the company take out policies on the co-owners. Upon the death of a co-owner, the company would redeem his or her stock. This method allows the premiums and purchase price to come from corporate funds, rather than personal funds. However, the insurance premiums would not be deductible by the company and depending on the type of entity, there can be different tax traps by having the company as the beneficiary.

If ownership will not transfer via a purchase but rather an inheritance, the current owner may want to provide funds for a beneficiary to be able to continue the company. The cost of estate and inheritance taxes may cause the company to be sold if there is no cash to pay for these taxes.

If the company stock is inherited by family of the sole or controlling owner, then split-dollar life insurance policies can be used to assist in paying the estate taxes. This allows the company to loan money to the owner for the payments of the premiums. There is interest that needs to be paid on the amount of the loan or imputed into the employee’s wages with the arrangement.

Upon the death of the owner, the company receives an amount equal to the cumulative premium payments with the balance of the policy payable to a personal beneficiary of the owner. The payment of the policy directly to the personal beneficiary removes the life insurance from the owner’s estate and assists the beneficiary in paying the estate and inheritances taxes.

Many businesses are dependent on owners or other key executives and the unexpected death of a key person can have a traumatic effect on the operation of the business. Therefore, the use of life insurance proceeds can be critical to the continued success of the company. Life insurance is owned and payable to the company to support the replacement of the key person.

A split-dollar arrangement may also be used to fund key-man life insurance. In this case, the key person would own the policy and the company would receive the death benefit. If the employee survives until retirement, the company would no longer require the life insurance policy and could relinquish its rights to the policy.

These are just some of the life insurance planning options available. The rules of the Internal Revenue Code and Regulations can be complex and if they are not followed properly, unintended problems may arise. It is important to have tax accounting, legal, and financial advice to structure these transactions properly.

Allison J. Shoemaker can be reached at Email or 215.441.4600.

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Allison J. Shoemaker, CPA

Allison J. Shoemaker, CPA

Director, Tax Strategies

Investment Industry Specialist, Business Tax Specialist, Individual Tax Specialist

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