Sunday, July 15, 2007

Buy/Sell Insurance – Protecting Everyone

Life insurance on the partners in a business can be an effective way to ensure that the business survives the death of a partner, and provides funds to the beneficiaries of the deceased partner.

When a death of a partner (partner in this context could be a shareholder, or limited liability company member) occurs it can have devastating effect on the business and of course, the lives of the family. Life insurance can provide funds to purchase the deceased partner’s interest providing an answer to the oft times tragic event.

There are two approaches to who owns the policy which may have a substantial effect on the surviving partner/shareholder/member. In both approaches the effect on the beneficiaries of the purchase is the same. Capital gain accrues to the purchase of the interest in the business.

In the first approach, the Company would own the policy, and would then buy the deceased partner’s interest. There would be no negative tax consequence to the Company but there would be no increase in basis for the surviving partners either. Upon sale or dissolution, the partners would pay tax on any profit without the benefit of the increased basis.

In the second approach, the partners would own the policy, and they would buy the deceased partner’s interest directly from the beneficiaries. In this approach the partners’ ownership basis would be increased by the transfer price to the beneficiaries, and upon subsequent sale of their interest, their gain would be reduced accordingly.

Buy/Sell agreements are not simple agreements as they usually indicate how the business will be valued. Therefore it should be in written form, and the use of experienced attorneys is advised.

Last item before signing off, is that in neither approach is the insurance premium a deductible expense.

This article was written by Dick Ginnaty, CPA (if there is any area in accounting or tax that you think needs to be addressed in this newsletter please e-mail Dick at Ginnatycpa@aol.com and if it is of general interest, he will address it in future articles).