| |
 |
Avoid
Tax Pitfalls When Your Corporation Buys Life Insurance |
Estate
plans often include life insurance to pay estate taxes. Beneficiaries
generally don’t owe income tax on insurance proceeds.
But when corporations buy life insurance for this purpose, the
proceeds can create income and other tax liability. Don’t
forget to consider these tax issues.
Here’s a quick look at five tax pitfalls that you can
avoid with proper planning.
Pitfall 1: Alternative Minimum Tax
Suppose a C corporation has a buy-sell agreement that calls
for stock redemption when a shareholder dies. The C corporation
owns and becomes the beneficiary of a life insurance policy
to fund the buy-sell agreement. The proceeds may affect calcula-tion
of the corporate alternative minimum tax (AMT) to the extent
the proceeds exceed the corporation’s basis in the insurance
policy. The Taxpayer Relief Act of 1997 eased this trap a bit
by repealing the AMT for some small corporations.
Pitfall 2: Transfer-for-Value Rule
If a redemption agreement has caused an AMT problem, you can
switch to a cross-purchase agreement by having the shareholders
buy the policies from the corporation.
Although this may solve the AMT problem, it may trigger the
transfer-for-value rule: If a policyholder transfers a policy
to the beneficiary in exchange for valuable consideration, the
death benefit is tax free only to the extent of the beneficiary’s
basis in the policy. The beneficiary pays ordinary income tax
on any proceeds received in excess of the basis. In short, the
insurance proceeds become taxable.
Here’s an example of how the transfer-for-value rule works:
Jim buys his mother’s $100,000 insurance policy for its
cash surrender value of $10,000. He then pays a $1,000 premium
for the next five years. When she dies, he receives insurance
proceeds of $100,000. What portion of the proceeds will be tax
free? Only the equivalent of his $15,000 basis — acquisition
cost plus premium payments. Jim will have to pay tax on the
remaining $85,000 — considered ordinary income.
The transfer-for-value rule doesn’t apply when a policyholder
transfers the insurance to:
| • |
The
insured |
| • |
A
partner of the insured |
| • |
A
partnership in which the insured is a partner |
| • |
A
corporation in which the insured is a shareholder or officer. |
Thus,
if the shareholders also are partners in an ancillary partnership,
the partnership can buy the policies without triggering the
transfer-for-value rule.
Pitfall 3: Estate Tax
If a corporation owns a policy insuring a shareholder’s
life and the proceeds are payable to someone other than the
corporation, the incidents of ownership in the policy may be
attributable to the insured and, therefore, includable in his
or her gross estate. This rule applies if the insured is a controlling
shareholder (a shareholder who owns more than 50% of a corporation’s
voting stock at the time of his or her death).
Of course, shareholders should consider the effect on their
estate plan of any buy-sell or stock purchase agreements in
place. A shareholder who owns less than 50% of a corporation’s
stock today may later become a controlling shareholder when
a parent, spouse or business partner dies. This will result
in the shareholder acquiring incidents of ownership owing to
the attribution rules and, thus, potentially adverse estate
tax consequences.
Pitfall 4: Estate Tax (On Increased Value of Stock)
When a corporation owns a policy insuring the life of a controlling
shareholder and the proceeds are payable to or for the benefit
of the corporation, the proceeds will not be included in the
shareholder’s gross estate. But the value of the stock
in the share-holder’s estate will, in all likelihood,
increase because the corporation will receive the proceeds.
Pitfall 5: Taxable Dividends
Generally, a corporate-owned policy on a noncontrolling shareholder’s
life won’t result in income tax consequences for the insured.
But if the beneficiary also is a shareholder, both the insured
(to the extent of premiums paid) and the beneficiary (to the
extent of proceeds received) may be deemed to have received
a benefit from the corporation that may be taxed as a dividend.
Protect Yourself
Without a doubt, if properly used, life insurance can help your
corporation avoid tax. But it may not work for you unless you
know how to avoid the possible tax pitfalls. We invite you to
contact our experts in this area to answer your questions about
this or other tax planning issues.
|
|
|
:
312.321.0300 > 
: 312.321.0364
> 
: