Society of FSP - Advisors Forum
Joint Teleconference
Exciting New Opportunities
In Buy-Sell Planning
with Life Insurance
Presented by
James Flick, JD, CLU, ChFC and
Timothy Messett, CLU
April 23, 2008
1
PLR 200747002
Innovative Use of a LLC to Structure and
Fund Buy-Sell Agreements
IRS approved the use of a LLC to own life
insurance purchased to fund a cross-purchase
buy-sell agreement for S corporation
shareholders.
2
PLR 200747002
Innovative Use of a LLC to Structure and
Fund Buy-Sell Agreements

The benefits of this structure include:
• Minimizes number of policies that must be purchased
• Avoids income taxation of the death benefit under the
transfer-for-value rule
• Keeps the policies out of the shareholders’ estates
• Protect the policies from business creditors
• Protect the policies from the shareholders’ creditors
• Assure compliance with the buy-sell agreement
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PLR 200747002
Innovative Use of a LLC to Structure and
Fund Buy-Sell Agreements
Background on Buy-Sell Planning

Stock Redemption (entity purchase)
•

Under a redemption arrangement, the corporation
redeems the shares of a deceased shareholder at his
death
Advantages
1.
2.
3.
The simplicity of only one life insurance policy per
shareholder
Premium costs are allocated to the shareholders
according to their percentage ownership in the
corporation
Assumes compliance with the terms of the buy-sell
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PLR 200747002
Innovative Use of a LLC to Structure and
Fund Buy-Sell Agreements
Stock Redemption (entity purchase)

Disadvantages
1.
2.
3.
4.
5.
The loss of the step-up basis
The insurance policies are subject to attachment by
the corporation’s creditors
If the corporation is a C corp, the death proceeds may
also be subject to the alternative minimum tax (AMT)
If corporate-owned buy-sell policies are over-funded
to provide non-qualified retirement benefits to the
owners, the benefits are generally taxable
For an S-corp owner, the results are slightly better
because the shareholder has some basis in the policy
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PLR 200747002
Innovative Use of a LLC to Structure and
Fund Buy-Sell Agreements
Cross-Purchase
Under a cross-purchase arrangement, each surviving
owner buys the deceased shareholder’s stock directly
from his estate

Advantages
1.
2.
3.
Because individuals own the policies and receive the
income tax-free death benefit, they can obtain a full
basis step-up by buying the stock directly from the
decedent’s estate
The common “wait and see” approach allows surviving
shareholders to keep the insurance proceeds for
themselves and use any retained corporate earnings
to effectuate a redemption
Policies are protected from the corporation’s creditors
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PLR 200747002
Innovative Use of a LLC to Structure and
Fund Buy-Sell Agreements
Cross-Purchase

Disadvantages
1.
2.
3.
4.
The most obvious disadvantage is the number of
policies required to accomplish the funding
Policies are subject to attachment by shareholder’s
creditors
A shareholder may fail to pay premiums or refuse to
pay death benefits pursuant to the buy-sell agreement
The premium burden is allocated based on the cost of
insurance of each other shareholder
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PLR 200747002
Innovative Use of a LLC to Structure and
Fund Buy-Sell Agreements
Trusteed Agreement
In a Trusteed Agreement, the policies are held by an
irrevocable trust with an independent trustee

Advantages
1.
2.
3.
The simplicity of only one life insurance policy per
shareholder
Premium costs are allocated to the shareholders
according to their percentage ownership in the
corporation
Assumes compliance with the terms of the buy-sell
agreement
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PLR 200747002
Innovative Use of a LLC to Structure and
Fund Buy-Sell Agreements
Trusteed Agreement

Disadvantages
The death benefits may be subject to income tax under the
transfer-for-value rule
a. First problem—emerges when there are more than two
shareholders and one shareholder dies. The beneficial
interests in the policies on the surviving shareholders
(which were owned by the decedent through the trust)
transfer to the other (uninsured) surviving
shareholders
b. Second problem—stems from the fact that the
shareholders, as beneficiaries of the trust, are the
beneficial owners of the insurance policies owned by
the trust
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PLR 200747002
Innovative Use of a LLC to Structure and
Fund Buy-Sell Agreements
Trusteed Agreement

Disadvantages
The death benefits may be subject to income tax under the
transfer-for-value rule
c.
Third problem—arises because each shareholder is a
beneficial owner of a proportionate share of his own
policy and effectively, through the trust agreement,
names the other shareholders as beneficiaries of the
policy
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PLR 200747002
Innovative Use of a LLC to Structure and
Fund Buy-Sell Agreements
The BILIT (business irrevocable life insurance trust)
The BILIT uses irrevocable life insurance trusts (ILITs) as
the centerpiece of the buy-sell arrangement. This
strategy calls for a cross purchase arrangement whereby
the policies each shareholder maintains on the other
shareholders are held in their own respective ILITs.

Advantages
1.
2.
Policies are protected from shareholder’s creditors
Policies are not an asset in shareholder’s estate
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PLR 200747002
Innovative Use of a LLC to Structure and
Fund Buy-Sell Agreements
BILIT (business irrevocable life insurance trust)

Disadvantages
1.
2.
3.
The administrative inefficiency caused by the need for
multiple policies on each shareholder is not avoided
The policies may not be withdrawn from the
arrangement without triggering taxation on cash value
gains
As in the case of any cross purchase arrangement, a
deceased shareholder leaves a transfer-for-value
problem in his wake
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PLR 200747002
Innovative Use of a LLC to Structure and
Fund Buy-Sell Agreements
BILIT (business irrevocable life insurance trust)
BILIT requires that the policies owned by the deceased
shareholder’s irrevocable trust that insure the surviving
shareholders are “purchased” by each surviving
shareholder’s irrevocable trust. The death benefit on
these two policies will then be taxed as ordinary income
under the transfer-for-value rule.
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PLR 200747002
Innovative Use of a LLC to Structure and
Fund Buy-Sell Agreements
New Approved Structure
1.
2.
3.
4.
Shareholders execute a cross purchase agreement
Shareholders form a LLC, taxed as a partnership, to
own life insurance
The cross purchase agreement and LLC operating
agreement have provisions that reference each other
Special provisions of LLC:




Manager is a corporate trustee. Any replacement must be
a corporate trustee or an “independent” person
Members cannot vote on life insurance matters
Manager must use life insurance proceeds as required in
the buy-sell agreement
A capital account is maintained for each member, with
special allocations of premiums and proceeds
14
“LifeCycle” Buy-Sell: Original Use of a LLC
to Structure and Fund Buy-Sell Agreements
Differences with PLR:
1.
2.
3.
PLR uses term insurance - LifeCycle uses cash value
insurance
PLR limited to funding death buyout - LifeCycle can
also be used for non-qualified retirement benefits
PLR LLC has more restrictive operating agreement for example, LifeCycle does not require a corporate
trustee as manager and restricts a member against
voting only on policies on such member’s life (author
of PLR admits that more restrictive provisions only
necessary if seeking a letter ruling)
15
Are Death Benefits Included in the Estate of
the Deceased Partner/Member?

No, in PLR 200747002 and in PLR 200214028, IRS ruled
that a partner/member does not possess any incidents of
ownership in policy provided the death benefit proceeds are
payable to or for the benefit the partnership/LLC. Since
deceased partner/member does not possess incidents of
ownership, the death benefits are not included in the
decedent’s under IRC Section 2042(2).
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How Are the Premium Payments Funded?
Usually paid by the underlying business entity for
the owners/employees.
• Payments are generally treated as bonuses under IRC
Section 162.
• If business is taxed as an S corporation, payments can
be treated as shareholder distributions.
• Each premium payment is treated as a contribution of
capital by the partner/member.
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Can Life Insurance With Cash Values be
Used?
•
•
PLR 200747002: Neither in its statement of facts nor in its
law and analysis does the IRS mention whether the policies
are term or have cash values.
PLR 200214028: The statement of facts do not specifically
state that the subject policies have cash value. However, it
does state that a withdrawing partner has the option to
purchase the policy on his life for its “surrender value”,
implying that the policies do, or could, have cash values.
• In PLR 200214028, the IRS held that life insurance
policies on decedent’s life held by and payable to a
partnership under terms of partnership agreement to
facilitate buy-out of decedent’s interest without
liquidation of partnership aren’t included in decedent’s
gross estate under Code Sec. 2042.
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Special Planning Required When Life
Insurance With Cash Value is Used.

When a LLC is used in conjunction with a Business Buy-Sell
Agreement, there are two buy-out obligations, the business
buy-out and the LLC buy-out. If the policies purchased by
the LLC will accumulate significant cash values, the life
insurance death benefits should increase at least as fast as
the cash value or additional death benefit should be
purchased (in addition to any increases required to
accommodate increases in the value of the business).
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