Business estate
planning:
How to preserve your life's work
You've spent a lifetime building your business.
Take a moment to make sure that your hard
work will survive the death of you or one
of your partners.
As the owner of a closely-held business,
much of your wealth is probably tied up
in the business. While returning earned
income back into the business helps finance
growth, it can cause severe liquidity problems
for your estate when you die. After paying
probate and estate taxes, your estate and
surviving family members also may encounter
liabilities that become payable upon your
death. They may also face the potential
of decreased business earnings, due to your
absence.
There are ways to overcome these liquidity
problems. Business-oriented planning tools
can help reduce estate taxes and make the
best use of the cash available. The most
common business estate-planning tools are
buy-sell agreements, Section 303 stock redemptions,
Section 6166 estate tax deferrals and the
qualified family-owned business exclusion.
Business-owned life insurance can be used
to fund each of these planning methods.
Buy-Sell Agreements
Buy-sell agreements can establish the value
of your business for estate-tax purposes
and improve your estate's liquidity by assuring
a ready market for your business upon your
death. These agreements also protect business
partners from sharing ownership with a deceased
stockholder's family.
There are two main forms of buy-sell agreements:
cross-purchase and stock redemption. In
an insurance-funded cross-purchase arrangement,
each business owner buys an insurance policy
on the other, naming themselves as beneficiary.
At the death of one of the owners, the surviving
owner receives tax-free insurance proceeds
to use in purchasing the deceased owner's
stock from his or her estate.
In an insurance-funded stock-redemption
arrangement, the corporation purchases the
stock of a deceased shareholder. Here the
business is the owner and beneficiary of
life insurance policies on each shareholder.
A partnership looking for a business continuation
plan may use a similar arrangement called
an entity purchase.
A buy-sell agreement that is funded with
life insurance will benefit:
Your Family:
- Prevents conflict with surviving owners
- Ensures that your family receives
a fair price for your business
- May set the value of your business
for estate-tax purposes
- Provides needed cash
Your Business:
- Keeps new and/or unwanted owners
out of the business
- Prevents disputes
- Ensures continuity and orderly transfer
of ownership
- May provide tax-free cash to purchase
stock
Section 303 Redemptions
Section 303 of the Internal Revenue
Code gives your estate a one-time opportunity
to remove cash or other property from
your business, at little or no tax cost,
through a partial redemption of your
stock. This can provide the liquidity
your survivors need to pay funeral costs,
estate and administrative expenses,
and state and federal death taxes.
To be eligible for a Section 303 redemption,
the stock value must exceed 35 percent
of your estate. The maximum amount that
can be paid under such a plan equals
the total amount of the federal estate
tax, state death taxes, funeral and
administrative expenses. Corporate-owned
life insurance can be used to fund the
redemption. Under this arrangement,
your business purchases an insurance
policy on your life and at your death
uses the tax-free proceeds to buy enough
stock from your estate to cover death
expenses and taxes.
Section 6166
An estate tax burden can force the
liquidation of a closely-held business.
Internal Revenue Code Section 6166 was
designed to prevent this liquidation.
If the business interest constitutes
more than 35 percent of your adjusted
gross estate, under Section 6166 the
executor may elect to pay the estate
tax attributable to the value of the
business in 10 annual installments,
beginning no later than five years after
the date of your death.
There are a number of requirements
you'd have to meet to be eligible for
the Section 6166 extension. If your
estate qualifies, life insurance offers
an economical way to pay these installments.
Qualified Family-Owned Business
Exclusion
If your business qualifies as "family
owned," you may be able to exclude part
of it from estate taxation. The amount
you can exclude is $675,000 if the death
of the estate owner occurs in 1998.
That qualifying amount gradually decreases
over time to $300,000 if the death occurs
in the year 2006 or later. Your business
qualifies as family owned if the business
comprises more than 50% of your total
estate and you pass the estate on to
a "qualified heir." A qualified heir
is generally defined as a spouse, child,
grandchild or other descendent. Your
heirs, however, should realize that
they have to hang onto the business
for at least 10 years following such
an estate transfer. If they don't, they
may have to pay the full estate taxes
that were avoided. Life insurance can
provide your heirs with the cash necessary
to pay estate taxes whether or not you
qualify for this exclusion.
Business Valuation for Estate Planning
No matter what technique you select
for your company, determining the value
of the business is a key step in the
estate planning process. Why? First,
in the case of a buy-sell agreement,
you need to know the value of the business
to determine the price and fund the
agreement. Second, because the business
is part of your estate, the valuation
is needed to estimate the estate taxes;
this helps you calculate the cash or
liquidity needed to administer the estate.
Finally, the value of the business must
be reported on the estate tax return
when the owner dies.
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Business
continuation planning:
Prepare for the continued success of
your business after you're gone.
Business continuation planning tools
can help you avoid the problems that
can occur when a business owner dies.
A life insurance funded business continuation
plan provides a wide variety of benefits
for your family and the business.
For your family:
- Prevents conflict with surviving
owners
- Assures a fair price for the business
- May set the value of your business
for federal estate tax purposes
- Can provide cash for your estate
For the business:
- Allows you to maintain control
of the business
- Prevents disputes
- Assures orderly transfer of
the business upon death
- Provides an income tax-free
death benefit to purchase shares
of the business
Several business continuation
plans are available:
Cross Purchase Plan
An agreement between co-owners
of a business. Surviving owners
purchase pro rata shares of the
deceased owner's stock from the
estate. To fund the purchase, each
stockholder owns, pays premium on
and is the beneficiary of an appropriate
amount of life insurance on the
other owners.
Stock Redemption/Entity Purchase
Plan
The business becomes obligated
to purchase the stock or partnership
share of a deceased shareholder
or partner. The business owns, pays
premium on and is the beneficiary
of life insurance on each shareholder
or partner.
LifeCycle Buy-Sell
Combines the benefits of the traditional
stock redemption and cross purchase
methods. Provides several benefits,
including the ability to supplement
retirement income and allocate the
premiums as desired.
Section 303 Stock Redemption
Plan
A special type of stock redemption
plan that can provide cash to the
estate of a deceased shareholder
in a tax-favored manner. Allows
a corporation to redeem a deceased
shareholder's stock without incurring
income taxable dividends. The potential
for dividend taxation upon a stock
redemption exists when a business
is passed on to surviving family
members.
One-Way Buy-Sell Agreement
Allows a single key employee or
an outsider to purchase the business
outright from the business owner's
family using the death proceeds
from a life insurance policy following
the business owner's death.
Consult your financial Advisor,attorney
and other financial professionals
for more information about creating
a Business Continuation Plan that's
right for you.
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Executive
Bonus Plans:
Reward key employees with life
insurance paid with deductible business
dollars
Your key employees are an important
reason that your business is profitable.
Employers often use selective, discriminatory
fringe benefits to reward those
employees whose work is more responsible
for creating profits. An Executive
Bonus Plan is one of these selective
benefits.
How an Executive Bonus Plan
works:
- The employee takes out a personal
life insurance plan and names
a beneficiary.
- The business pays the policy
premium to the insurer. It can
deduct the premium on its income
taxes as long as the total payments
to the employee are considered
reasonable compensation.
- The employee pays income taxes
on the premium
Benefits for the company and
key employees
Advantages to the company include:
- Easy administration
- Premium payments are deductible
expenses
- IRS qualification/reporting
is not required
- You select participants
- It is relatively inexpensive
- You can terminate the plan
at any time
Advantages for key employees
include:
- Business dollars pay most
of the employees' costs
- The employee's beneficiary
receives an income tax-free
death benefit
- The remaining small cost
can be decreased further using
policy dividend options
- They own and control the
policy and its cash values
- It is portable — they
can take it with them when
they leave the company
An Executive Bonus Plan can
be an excellent low-cost method
to reward employees whose
hard work helps make your
business profitable.
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<>Key
Person Insurance:
Protect your business against
the loss of one of your most
vital assets: key employees
Key people are vital to the
success of your business.
A Key Person Life Insurance
Plan can provide the funds
you need to keep your business
running smoothly after you've
lost a key employee through
death or employee turnover.
How Key Person Life Insurance
works:
The employer pays premiums
for a life insurance policy
on the key employee's life.
The employer is the owner
and beneficiary.
The employer can arrange
an Exchange of Insurance Agreement
to reduce losses if a key
employee leaves prior to retirement.
This allows the employer to
transfer coverage to a successor.
If a key employee dies, the
employer receives the policy's
income tax-free death benefit*
and can apply it towards business
expenses or losses caused
by the employee's death.
If you employ anyone whose
sudden, unexpected absence
would significantly impact
your business, consult with
your Financial Advisor and
other financial professionals
about Key Person Life Insurance.
* Subject to the corporate
alternative minimum tax for
C corporations.
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Life
Rewards:
Select nonqualified retirement
benefits for your key executives
The benefit program your
company offers is critical
to attracting and retaining
top employees. Qualified benefit
programs — pension and 401(k)
plans — limit participation
by highly compensated executives.
A nonqualified plan is a unique
benefit designed to attract
and reward top executives.
Life Rewards, a customized
nonqualified benefit program,
can strengthen the tie between
your company and its top executives.
You can provide Life Rewards
for your key executives to:
- Secure the services
of your most influential
executives that may impact
profitability.
- Attract new managers.
- Build loyalty in today's
high turnover marketplace.
- Provide a second tier
of benefits to highly compensated
executives disadvantaged
by qualified plan limitations.
Three Life Rewards strategies
are available:
Executive Deferral Plan
Allows the executive to
defer a portion of base
salary, bonus or commissions,
which lowers currently taxable
income.
Deferred Bonus Plan
Restricted solely to discretionary
employer contributions and
rewards the executive subject
to a vesting schedule you
select.
Executive Salary Continuation
Plan
Protects against inflation
to help your valued executives
achieve a comfortable retirement.
Funded entirely with company
dollars.
Life Rewards offer valuable
benefits to key executives:
- Lower currently taxable
income during their working
years
- A survivor benefit
for their family
- Tax deferred growth
of retirement assets
- Parity for executives
limited by qualified plan
restrictions
Who can sponsor a
nonqualified Life Rewards
plan? Any company
can establish a nonqualified
Life Rewards plan. C corporations
best complement the tax
advantages of a nonqualified
plan; however, nonshareholders
of an S corporation also
benefit. Other entities
such as a limited liability
company, limited liability
partnership, sole proprietorship
or partnership may also
sponsor a nonqualified
plan for select nonowner
executives.
Life insurance?
Planning Concepts
Planning Concepts
