Can Group Life Insurance be Used to Fund a Buy-Sell Agreement?

The use of group insurance to fund a buy-sell is generally not a sound idea. First, if the buyout price is artificially reduced in return for a corresponding increase in the group term coverage (under the pretext that “This makes your buy-sell partially tax deductible. What’s the difference where the family gets the money as long as they get the same number of dollars?”). The difference is that the family is cheated because it does not receive a fair price for the business interest held by the estate plus the group insurance to which it is entitled. Furthermore, since the IRS is likely to claim that the corporation is an indirect beneficiary of the group term insurance (by virtue of the reduction in the buy-sell price) the premium for the additional life insurance may not be deductible. Moreover, the price set in the agreement will not be binding on the IRS or on the courts, and the estate could conceivably pay an estate tax greater than the money it receives for the stock.

Another ploy that will be unsuccessful (and that is dangerous from a tax viewpoint as well) is for two shareholders to sign a cross-purchase buy-sell agreement and name each other the beneficiary of the coverage on their respective lives. In return, they lower the price of a decedent’s interest in a buy-sell. Under these circumstances, there has been a transfer of an interest in a policy (i.e., when one shareholder named the other as beneficiary), and that transfer of interest has been made for valuable consideration (i.e., reciprocity of the other’s action). This is clearly a “transfer for value” and it will cause the proceeds to be income taxable.

Yet another trick that is periodically suggested is to name one’s own family as the beneficiary of an increased amount of group term life, but agree that the increase will in turn be considered payment made to the family of the deceased insured in return for full or partial payment for his or her stock. Mechanically, it is almost impossible to match insurance needs with the group schedules of benefits because of the nondiscrimination rules. Furthermore, once the family has received the proceeds, but still holds the stock, if they decide not to transfer the shares, how (aside from an expensive and aggravating lawsuit) will the surviving shareholder obtain the stock?

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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