Planning for Business Owners and Professionals
Entity choice drives everything downstream
Sole proprietorship, partnership, LLC, S corporation, and C corporation differ on self-employment tax, fringe-benefit deductibility, and exit strategy. S corporation more-than-2% shareholders are taxed on many fringe benefits; C corporations face double taxation on dividends; entity type determines whether a buy-sell is a redemption or a cross-purchase.
Buy-sell agreements
Two structures: cross-purchase (each owner buys the shares of a deceased owner; survivors receive a §1014 step-up in basis) and entity redemption (the business buys back the shares; no basis increase to survivors, but fewer policies and simpler administration). Variations include wait-and-see, one-way, and trusteed arrangements. Fund with life insurance, watching the transfer-for-value rule - transfers to a partnership or to a corporation in which the insured is a shareholder or employee are excepted; a sale to an unrelated third party is not.
Business and estate tax tools
§303 permits a redemption up to the amount of death taxes plus funeral and administration expenses, taxed as capital gain rather than dividend. §6166 defers estate tax on a closely held business (2% rate on the first tranche). §2032A allows special-use valuation of farm and real property. Key-person premiums are nondeductible; proceeds are generally tax-free under §101(a). Executive bonus (§162) premiums are deductible by the employer and taxable to the employee; a double bonus grosses up.
Traps
- §303 and §6166 both require the business interest to exceed 35% of the adjusted gross estate.
- Split-dollar economic-benefit regime versus loan regime changes who reports income.
- Premiums are generally not deductible when the business is the beneficiary.
Worked example
Adjusted gross estate $5 million; includible business stock $2 million (40%) - the 35% test is met, so both §6166 deferral and a §303 redemption sized at death taxes plus expenses are available.