Is Life Insurance taxable if corporation pays for it

[Scottie B]

I am going through a buy sell set up with my partner and she can be a game player. One of the provisions is I wanted life insurance for my wife for 20 years. A man quoted me for $650,000 and said it was tax free and that my company would pay the insurer and upon my death, that trust would pay my wife but then a friend told me that it is taxable. I asked the person if true and his statement was "Your company is funding the trust. The trust is funding the policy. This is not a corporately owned plan". Question. Is this true?

 

[TampaHound]

Talk to your tax adviser....

 

[DHK]

I am going through a buy sell set up with my partner and she can be a game player. One of the provisions is I wanted life insurance for my wife for 20 years. A man quoted me for $650,000 and said it was tax free and that my company would pay the insurer and upon my death, that trust would pay my wife but then a friend told me that it is taxable.

For that amount, the life insurance proceeds would NOT be taxable... as long as you don't deduct the premiums for the life insurance from your business or personal tax returns. It doesn't matter if it's a sole-prop, partnership, LLC, or Corporation. If you deduct the premiums, the proceeds would become taxable. Why? Because your company is the ultimate beneficiary.

It is possible that proceeds could be subject to the Alternative Minimum Tax... so that could be a possibility to talk to a tax advisor about.

I asked the person if true and his statement was "Your company is funding the trust. The trust is funding the policy. This is not a corporately owned plan". Question. Is this true?

I am not an expert in funding business buy-sell agreements. Essentially, a buy-sell agreement is a kind of trust because it manages the expectations of multiple parties in the event of death. However, I'm not certain that the buy-sell agreement becomes a "trust" at death. (It can certainly be tied up in court for years and have attorneys representing the various parties of the agreement.) A true trust can become a separate entity in and of itself. Again, I am not an expert in this kind of planning, and perhaps I am taking your/their comment to be a little too literal.

A buy-sell agreement is a legal agreement, not necessarily a trust. But an agreement without being able to fund it... becomes meaningless.

So, let's look at it the proper way: Your company has a buy-sell agreement between 2 or more owners. You draft an appropriate and legal agreement. Your company buys life insurance on the multiple owners (entity purchase) to fund the agreement in the event of death of any owner.

Policy owner: Company
Policy payor: Company checkbook
Policy beneficiary: Company (per the stipulations in the buy-sell agreement to transfer ownership rights to remaining owners in exchange for the proceeds of the policy)

As long as you don't deduct the premiums, the proceeds will be income tax-free to the company - aside from any possible Alternative Minimum Tax scenarios.

 

[eersfan]

"Policy owner: Company
Policy payor: Company checkbook
Policy beneficiary: Company (per the stipulations in the buy-sell agreement to transfer ownership rights to remaining owners in exchange for the proceeds of the policy)"

What you have described is an entity-purchase buy-sell agreement, which is commonly used when there are more than four owners. In this case, the stock of the deceased owner does not revert to the surviving partners, but becomes treasury stock. As such, the surviving owners do not get a step-up in basis for their share of the ownership. In a cross-purchase agreement, surviving owners use the policy proceeds to purchase the deceased owner's share and do get a step-up in cost basis.

 

[eersfan]

" Essentially, a buy-sell agreement is a kind of trust because it manages the expectations of multiple parties in the event of death. However, I'm not certain that the buy-sell agreement becomes a "trust" at death. (It can certainly be tied up in court for years and have attorneys representing the various parties of the agreement.) A true trust can become a separate entity in and of itself. Again, I am not an expert in this kind of planning, and perhaps I am taking your/their comment to be a little too literal."

A buy-sell agreement is not a trust but merely a legal document that spells out what happens to the ownership of stock when a partner dies. What is often overlooked is that most agreements address two eventualities...death and disability. Rarely is the disability aspect funded. I've written a ton of disability buy-out coverage over the years as a result of it not being funded.

 

[eersfan]

I am going through a buy sell set up with my partner and she can be a game player. One of the provisions is I wanted life insurance for my wife for 20 years. A man quoted me for $650,000 and said it was tax free and that my company would pay the insurer and upon my death, that trust would pay my wife but then a friend told me that it is taxable. I asked the person if true and his statement was "Your company is funding the trust. The trust is funding the policy. This is not a corporately owned plan". Question. Is this true?

If you want your company to purchase the insurance on your life with the proceeds to go to your wife, this is separate from a buy-sell agreement. Your company can pay the premiums but not deduct them.