Business Life Concepts
Business Life Concepts tests how life insurance solves business problems - continuation, key-person indemnity, executive compensation - and how the tax code treats each arrangement. Questions turn on who owns the policy, who is the beneficiary, who gets the deduction, and who recognizes income.
Buy-sell agreements
- Cross-purchase: each owner buys a policy on every other owner. With three owners that is six policies; survivors receive a basis step-up to the purchase price.
- Entity purchase (stock redemption): the business owns one policy per owner, buys the deceased's shares, and survivors get no step-up.
- A workable agreement names a valuation method, trigger events (death, disability, retirement, divorce), and payment terms, and policy ownership must match the agreement.
- A one-way buy-sell funds a sale from a sole owner to a key employee.
Key person insurance
The business owns the policy and is beneficiary; premiums are not deductible, and proceeds are generally income-tax-free under IRC §101(a). It indemnifies for lost profit, funds a buyout, or satisfies lenders.
Executive benefit arrangements
- Executive bonus (§162): employer pays the premium, deducts it as compensation, and the employee is taxed on it. A double bonus grosses up the tax; vesting creates a substantial risk of forfeiture.
- Split dollar: endorsement (employer owns the policy) or collateral assignment (employee owns it). Taxation follows the 2003 final regulations - economic benefit or loan treatment - ending with a rollout.
- Deferred compensation: nonqualified, governed by §409A; Rabbi trust; no deduction until paid, no income until received.
- IRC §79 group term: $50,000 of coverage can be provided income-tax-free; the Table I cost of excess coverage is imputed to the employee; nondiscrimination rules apply.
- COLI/BOLI must satisfy §101(j) notice-and-consent or the death benefit becomes taxable; exceptions are narrow and include certain key employees, directors, and highly compensated insureds.
Worked example
Three equal owners, each interest worth $1 million. Cross-purchase requires 3 × 2 = 6 policies; entity purchase requires 3. If future basis matters - the survivor later sells the business - cross-purchase gives a stepped-up basis equal to the price paid. Entity purchase is simpler and cheaper but leaves basis unchanged and exposes the policies to company creditors.
Traps that cost marks
Assuming buy-sell premiums are deductible; assuming a buy-sell agreement fixes estate tax value (it must satisfy §2703); forgetting §101(j) consent; mismatching beneficiary to the agreement; ignoring state law limits on stock redemption.