Client is wondering if he could put his wife as a contingent for his Buy/Sell.

[LifeInsurancePro]

It's not clear how they're paying for the insurance yet for the buy/sell, his wife isn't involved in the business, but what kind of tax ramifications could they expect to see if she ended up as the beneficiary.

 

[DHK]

For whom is he doing the buy/sell FOR?

Think about it.

The idea is to buy the business interest from the non-involved spouse so the business can continue and the spouse receives the value from the planning done.

The spouse is the beneficiary of the buy/sell. The other party is the beneficiary of the life insurance. Then, by agreement, they are to purchase the wife's ownership interest using the proceeds.

You need someone who can do this on a basic level. Run it by the client's business attorney and your advanced underwriting department.

 

[DHK]

Regarding tax ramifications, could be little to none. Why? Step-up in basis of the business value/interest. Could have estate tax issues though.

I'm not an expert in business planning, but I did stay at a Holiday Inn last night.

 

[scagnt83]

Generally speaking, no. But it depends.

For an Entity Purchase Buy/Sell Agreement. The Business is listed as the Bene. So no possibility of the wife being listed.

For a Cross-Sell Buy/Sell Agreement. The other Partners of the firm are listed as Bene... since the other partners are responsible for paying the Insureds wife if they pass. There is no need for a contingent since deceased partners and their subsequent estate are usually eliminated from business ownership (payed out) with most professionally written buy/sells agreements. (if the primary bene is no longer part of the business if deceased.... no need for a contingent)

But if there are just 2 partners in a cross-sell agreement. Then its possible to list the wife as Contingent. Since one would assume the policy would just be used as personal insurance at that point if no other business partners were taken on by the Insured.

It is critical to know what the buy/sell agreement is and dictates. That is the only way to know how to structure the polices correctly. Your flying the plane blind without it.

Also, with an Entity Purchase, it would technically be illegal for you to allow the Insured of the policy to dictate any details beyond what the application asks about info on the Insured. Because the Owner and Payor of the policy is the Business Entity, and only the Owner of the policy can dictate who the beneficiaries are.

Always be aware of the "goodman triangle" when doing business planning. Cant have 3 different parties on a policy. So you cant have the business pay for insuring a partner and the policy pay out the wife. This makes the DB taxable as income.

 

[Allen Trent]

Step-up in basis of the business value/interest

depends on type of buy sell agreement. If entity purchase, the value of the business could actually increase if the business received the death benefit.

Also, making the spouse the contingent could contradict the individuals estate planning if their will or trust indicated children were to receive certain assets, especially in second marriages or large estates.

Best to never guess & have the business/estate planning attorney tell you who should be policy owner, policy primary & policy contingent bene. It needs to be in exact coordination with the legal buy sell document & the estate planning documents. Too many business successions & estates get lopsided by improper asset ownership or policy beneficiary designation

 

[scagnt83]

depends on type of buy sell agreement. If entity purchase, the value of the business could actually increase if the business received the death benefit.

That shouldnt be an issue generally speaking. Valuation of the payout is at maximum at time of death. And the payout stipulated in the buy/sell would be considered a debt to the business until the funds were distributed. So its a wash.

 

[Allen Trent]

That shouldnt be an issue generally speaking. Valuation of the payout is at maximum at time of death. And the payout stipulated in the buy/sell would be considered a debt to the business until the funds were distributed. So its a wash.

I believe there are more potential pitfalls to this depending on if the buy sell document valuation included or didn't include the amount of insurance. Also, can be a tax issue for a C corp & AMT tax. Lastly, surviving shareholders cost basis is not increased by the amount of the life insurance received by the entity.

Just saying I would never provide any advice in regard to who should own or be the primary or contingent. I would only supply 3rd party expert resource documents & steer them back to the attorney & CPA. Can make the process longer, but we don't practice law or hold CPA licenses normally to make those big decisions that require interpreting a legal buy sell document

Edit. Forget to add a reference link of things I was thinking of:. Effects of Life Insurance on the Valuation of Stock

 

[scagnt83]

I believe there are more potential pitfalls to this depending on if the buy sell document valuation included or didn't include the amount of insurance. Also, can be a tax issue for a C corp & AMT tax. Lastly, surviving shareholders cost basis is not increased by the amount of the life insurance received by the entity.

A standard buy/sell agreement does not include the amount of insurance. Nor does a standard business valuation.

Think about it, why would it? The insurance DB paid to the firm, is already contractually promised to the surviving spouse. It is legally a contractual debt obligation held by the company. If they neglected to pay it, the spouse could sue them just like any other creditor

Same as any other business debt, its subtracted from the value. So its a wash.

And what business owner would agree to that? Think if you and I went into business together Allen. You die when our business is worth $5m... the biz gets a $2.5m DB that legally must be paid to your wife... and you want me to agree to include that $2.5m in the valuation making the biz pay your wife $3.75m instead of the $2.5m the biz was actually worth when you died?? That is just illogical. Who on earth would agree to that? Would you agree to that? Would you want to pay my wife $1.25m more than what the business was worth when I die?

 

[scagnt83]

Just saying I would never provide any advice in regard to who should own or be the primary or contingent. I would only supply 3rd party expert resource documents & steer them back to the attorney & CPA. Can make the process longer, but we don't practice law or hold CPA licenses normally to make those big decisions that require interpreting a legal buy sell document

As someone who used to work this market heavily. I disagree.

It is absolutely my job as an agent to advise the client on the appropriate policy setup. Including ownership and the correct beneficiaries. That is why this subject matter is included in advanced insurance designations and in CE courses about business insurance.

Lawyers are experts on the legal side. We are the expert on the insurance side.

Go tell your E&O "the attorney told me the wrong person to list as Owner". Their response will be "the attorney was not the insurance expert who sold the policy and signed off on everything being correct".

Plus, you are making a big assumption that the attorney knows what they are doing. Some do not understand the funding side of the buy/sell at all. Some just "dabble" in doing buy/sell agreements but arent true experts. Unless you just know the attorney and their expertise, you have no clue if they are competent or not. Why should I trust my clients business and my business to this random person who may or may not be fully competent to answer insurance related questions?

We are the insurance expert. If we are working a buy/sell case, it is 100% our job to know what parties go on what line of the contract based on the type of buy/sell in place. This isnt something that changes based on the situation, this is a cut and dry factual matter that is constant for each case.

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And as agents, we are legally able to give tax info related to the products we sell. Its not tax advice, its factual info. There is a difference.

If there are 3 different parties on the app... its a goodman triangle and the DB is taxable. That is not advice, its factual info.

If the business pays for the policy but the spouse is listed as bene... premiums are taxable to the employee as income. Factual info, not advice.

An Entity Purchase Buy/Sell Agreement requires that the business entity be Owner & Payor on the policy. Factual info, not advice.

Im not telling them what to do or not to do, Im telling them what will happen IF they do that. The choice is theirs.

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If an agent doesnt know, Id suggest they get advanced planning on the phone for the carrier they are selling. But if they dont know, they probably shouldnt be working the case solo in the first place.

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Now if I was asked about AMT tax ramifications of a C-Corp receiving the DB. I would refer them to their CPA because that is not a cut and dry issue with just 1 factual answer to provide. It is situational, so it requires tax advice.

If I was asked if the DB was included in the valuation... I would tell them 99% of the time no, but check with your attorney who wrote the buy/sell to make sure it does not include it. And I would tell them to check with their CPA about valuations in general and the effect of the DB/debt obligation the situation creates.

But who should be Owner/Payor/Bene/Insured... that is an agents job to give factual info along with recommendations.

 

[Allen Trent]

A standard buy/sell agreement does not include the amount of insurance. Nor does a standard business valuation.

Think about it, why would it? The insurance DB paid to the firm, is already contractually promised to the surviving spouse. It is legally a contractual debt obligation held by the company. If they neglected to pay it, the spouse could sue them just like any other creditor

Same as any other business debt, its subtracted from the value. So its a wash.

And what business owner would agree to that? Think if you and I went into business together Allen. You die when our business is worth $5m... the biz gets a $2.5m DB that legally must be paid to your wife... and you want me to agree to include that $2.5m in the valuation making the biz pay your wife $3.75m instead of the $2.5m the biz was actually worth when you died?? That is just illogical. Who on earth would agree to that? Would you agree to that? Would you want to pay my wife $1.25m more than what the business was worth when I die?

Agree. But many times it is recommended to have in writing an agreed to method of how to or what valuation methods will be used for death, disability, retirement. I am certain you have the skill & experience, but that just isn't the case today with the majority in our field. I am just saying there is a fine line between giving generic insurance advice & practicing law in some of these business cases. I see a lot of new agents or novice in these markets taking a whirl at helping their buddy or family member in a growing newer business

Effects of Life Insurance on the Valuation of Stock