Buy-Sell Funding
Another planning opportunity for partnership-owned life insurance deals with buy-sell agreements. Buy-sell agreements for corporations with more than two shareholders create several potential problems. First, with the popular cross-purchase or wait-and-see buy-sell agreement (so that the surviving shareholders receive a stepped-up basis in their shares and a C corporation avoids paying the Alternative Minimum Tax), either a trusteed buy-sell arrangement must be used or multiple policies must be purchased (i.e., each shareholder must own a policy on each other shareholder's life). For example, with four shareholders, you would need 12 policies. Second, a transfer-for-value may occur at the death of a shareholder as the deceased shareholder's interests in the surviving shareholders' policies are purchased by the surviving shareholders. If so, a portion of the insurance proceeds will be subject to income taxes. IRC Section 101(a)(2).
To avoid both of these problems, the shareholders could form a general partnership or limited liability company to own the policies with which to fund the corporate buy-sell agreement. Similar to a trusteed buy-sell arrangement, only one policy per shareholder is needed. The partnership / operating agreement will provide that any life insurance death proceeds be specially allocated to just the surviving shareholders. At the death of a shareholder, there will be no transfer-for-value problems, because the transfer of policies to a "partner" of the insured is an exception to the transfer-for-value rule. IRC Section 101(a)(2)(B). In addition, partnerships and LLCs are not subject to the Alternative Minimum Tax.
Julius H. Giarmarco, J.D., LL.M, is the Chair of the Estate Planning Group of Giarmarco, Mullins & Horton, P.C., Troy, Michigan.
