Presentation on theme: "The Role of Life Insurance in Business Succession Planning"— Presentation transcript:
1 The Role of Life Insurance in Business Succession Planning Julius H. Giarmarco, Esq.
2 Family Facts Father: John (age 65) Mother: Mary (age 65) Son: Lawrence (age 35)Daughter: Jennifer (age 30)Lawrence is only child active in the family businessLawrence has 3 children and Jennifer has 2 children.
3 John & Mary’s Balance Sheet ValueResidence (Joint) $1,000,000Vacation Home (Joint) $750,000Business (S corp) (John) $5,000,000Building (LLC) (John) $2,000,000Non-Qualified Investments (Joint) $500,000IRAs (John) $750,000Life Insurance (John)Gross Estate $10,000,00011. Cost basis of $500,000; Assume 10% dividend and 4% principal appreciation.
4 John & Mary’s Objectives Retain control of the S corporation until retirement.Pass the entire business to Lawrence at John’s death.Retain one or two key-employees to assist in the transition periodTreat children fairly.Guarantee retirement income.Reduce or eliminate estate taxes.
5 Projected Estate Tax Liability in 2028 No federal estate taxes and expenses at first deathCurrent Net Estate $20,736,000Existing Life Insurance - 0 -Total Estate $20,736,000By-Pass Trust andOther Transfers$3,500,000Estate ofSurviving Spouse$17,236,000After Tax Estate$11,054,800Federal Taxes$6,181,20029.8%Distribution to HeirsAfter Tax Estate $11,054,800By-Pass Trust and Other Transfers 3,500,000Total $14,554,800Distribution to Family: 70.2%Assumes 4% growth through 2028.Assumes the estate tax exemption is $3.5M and the estate tax rate is 45%.
6 Options to Pay the Estate Tax if John & Mary Do Nothing 1. Good - IRC Section 6166 (5 year deferral; 10 year installment payment of estate tax)2. Better - IRC Section 303 (redemption of stock to pay death taxes)3. Best - Irrevocable Life Insurance TrustDiscounted dollarsCan purchase assets from estateCan loan monies to estate
7 Section 303 Redemption During John’s Lifetime InsuranceCompanyPays PremiumsS CorpObtains Life InsuranceJohnIf stock interest is more than 35% of adjusted gross estate, the estate will qualify for a partial redemption.Insured
8 Section 303 Redemption Upon John’s Death InsuranceCompanyPays Death BenefitsS CorpCashPartial redemption is not treated as a dividend.Family continues to retain an ownership interest.JohnStock PassesSome StockJohn’sLiving Trust
9 Advanced Techniques to Transfer Business to Lawrence During John’s Lifetime Private Annuity SaleSelf Canceling Installment Note (“SCIN”)Grantor Retained Annuity TrustInstallment Sale to Grantor TrustCharitable Stock Bail Out
10 Private Annuity Sale §7520 Rate 5% FMV of S Corporation $5,000,000 John’s Basis $500,000Payment Period AnnualInitial Annual Payout $473,979Single Life Expectancy (Age 65) 20 YearsCapital Gain Realized at Time of Sale $4,500,000Initial Annuity Payment BreakdownTax-Free Portion $256,410Ordinary Income Portion $217,568
11 Bullet Proofing the Private Annuity Sale John should consider funding an ILIT (for the benefit of Mary) to “replace” the annuity payments in the event of his premature death.Lawrence should consider purchasing life insurance to provide the funds necessary to continue the annuity payments should be predecease his father.
12 Self Canceling Installment Note §7520 Rate 5%FMV of S Corporation $5,000,000Cost Basis $500,000Initial Down Payment $0Term of Note 19 YearsType of Note Interest OnlyNo-Risk-Premium Market Interest Rate 5%Payment Period Annual
13 Self Canceling Installment Note Risk PremiumPrincipal InterestMortality Risk Premium (Principal) $2,619,628 N/ATotal Sale Price $7,619,628 $5,000,000Principal Amount of Note $7,619,628 $5,000,000Mortality Risk Premium (Interest) N/A %Annual Principal Payments $0 $0Annual Interest Payments $380,981 $428,083Balloon Payment at the End of Note $7,619,628 $5,000,000Total Interest to be Paid $7,238,646 $8,133,577Total Capital Gain $7,119,628 $4,500,000
14 Bullet Proofing a SCINJohn should consider funding an ILIT (for the benefit of Mary) to “replace” the note payments in the event of his premature death.
15 GRAT Trust Established JohnGRATTransfers S Stock(can be arranged with no gift tax)Pays Gift TaxIRS
16 IF JOHN DIES BEFORE END OF TRUST TERM GRAT During GRAT TermJohn(pays taxes ontrust income)GRATPays AnnuityIF JOHN DIES BEFORE END OF TRUST TERMJohn’s EstateGRAT(portion of propertysubject to estatetaxes)
17 GRAT At End of GRAT Term GRAT If John lives to end of trust term, property in GRAT is not subject to estate taxes.Remainder Paid toLawrence
18 Grantor Retained Annuity Trust §7520 Rate %John’s Age 65Income Earned by Trust % Annual Growth of Principal 5.00%Term/Number of Payments 10Pre-discounted FMV $5,000,000Discounted FMV $3,000,000Annual Percentage Payout %Beginning 5.00% 10.00% AnnualYear Principal Growth Annual Income Payment Remainder1 $5,000,000 $250,000 $512,500 $499,800 $5,262,7005 $6,316,539 $315,826 $647,445 $499,800 $6,780,01210 $9,456,952 $472,847 $ $499,800 $10,399,337Summary $5,000,000 $3,408,963 $6,988,374 $4,998,000 $10,399,337
19 Bullet Proofing a GRATJohn should consider funding an ILIT (for the benefit of Lawrence) to provide the funds needed to pay estate taxes should John die before the end of the GRAT term.
20 Installment Sale to a Grantor Trust JohnGrantor / Dynasty TrustJohn gifts 10% of S Corp stockJohn retains control as 10% voting shareholder(10% x $5,000,000 = $500,000 less 40% discount = $300,000)$500,000 FMVJohn receives $170,000 annually (from interest payment and $50,000 of dividends on the 10% voting shares)John sells 80% of S Corp stock$4,000,000 FMV(80% x $5,000,000 = $4,000,000 less 40% discount = $2,400,000)Trust earns 10% on $4,500,000 = $450,000/ yearTrust pays interest only for 20 years of $120,000 annuallyJohn pays income taxes of $210,000 ($500,000 x 42%) - for annual “short fall” of $40,000 ($210,000 – $170,000)($2,400,000 x 5%)Trust can use the excess cash flow of $320,000/year to purchase life insurance on John’s life or John and Mary’s joint life.Trust’s Cash Flow$450,000($120,000)$330,000Paying IDIT’s income taxes is equivalent of tax-free gift
21 Charitable Stock Bail Out John1. John transfers his voting shares to Lawrence and his non-voting shares to the CRT, leaving Lawrence the sole shareholder. This terminates Subchapter S election.2. John receives a charitable income tax deduction and income for the rest of his and Mary’s lives.CharitableRemainderUnitrust3. Stock is transferred from the trust to the S corp in exchange for cash.S Corp4. Life insurance can be purchased to “replace” the wealth passing to the CRT.
22 “Wait and See” Buy-Sell Agreement During Lifetime InsuranceCompanyBusinessAgreementPays PremiumsPays PremiumsJohnLawrenceEach Shareholder Obtains Life Insurance On The Other
23 “Wait and See” Buy-Sell Agreement Upon John’s Death InsuranceCompanyPays Death BenefitsS CorpOption toPurchaseMustPurchaseJohnLawrence1st3rdStock PassesOption to Purchase2ndJohn’sLiving Trust
24 Why Use Life Insurance to Fund Buy-Sell Agreement? Creates a lump sum of cash when needed.Results in a quick settlement of the buy-sell transaction.Generally, an income tax free death benefit.Income tax free access to cash values for a lifetime buy-out.
25 Key EmployeesCompany can purchase life insurance on the lives of its key employees to guard against financial loss.Company can provide key employees with an executive bonus.Company can implement a non-qualified deferred compensation plan to attract and retain key employees.Company can assist key employees in purchasing life insurance through a split-dollar plan.
26 Executive Bonus Company Insurance Company 2 1 3 Key Employee 1 Tax-deductible bonus from employer to key employee.2Bonus dollars fund a life insurance policy owned by the key employee. Key employee is taxed on the bonus as ordinary income.3Key employee uses the financial asset values to supplement retirement income or provide survivor benefits.
27 Non-Qualified Deferred Compensation Plan 2CompanyInsuranceCompany314KeyEmployee1Employer promises to provide future retirement benefit.2Employer may purchase life insurance to “informally” fund benefits.3Asset values help pay benefits and/or recover costs.4Benefits are paid based on contractual specifications.
28 Split Dollar Plan 1 2 3 1 Key Company Employee 3 2 Insurance Company A face amount and premium for a life insurance policy is determined and the employer lends this premium to the employee.2The loaned premium is used to pay for the life insurance policy. The employee owns the policy.3The employee executes a collateral assignment on the policy to secure the employer’s loan. Annual interest on the loan is assessed at an appropriate interest rate, often the Blended Annual Rate or Long-Term Applicable Federal Rate, as published by the Internal Revenue Service. The interest is usually treated as bonused income to the employee.
29 Split Dollar Plan 4 5 1 Key Company Employee 3 4 2 Insurance 5 Company The portion of the cash value or death benefit assigned to the employer to repay the loan is paid off at retirement or death, from the cash values, if available. Death benefit may be forgiven by the employer.5After paying off the loan to the employer and terminating the assignment, the employee may access policy values to supplement his/her retirement income or pass tax free death benefits to his/her descendants.
30 Estate EqualizationJohn and Mary can leave Jennifer their non-business assets.John and Mary can “make up” the difference by funding a survivorship ILIT for the benefit of Jennifer.
31 Estate Equalization John & Mary 1. John & Mary create an irrevocable trust, and make gifts of life insurance premiums to the trust.2. Pays Insurance Premium.InsuranceCompanyILIT fboJennifer3. Pays death benefit upon death of John & Mary – income and estate tax free!4. Transfers Cash.John & Mary’sEstate5. Transfers Assets.6. Pays Debts and Taxes.IRS
32 Family Bank Structure: A family LLC or family limited partnership. Members/Partners:Lawrence and Jennifer.Capital Contributions:Either gifts from John and Mary and/or contributions directly from Lawrence and Jennifer.FLLC’s/FLP’s Investments:A survivorship policy on John and Mary’s lives.
33 Family Bank Indicated Use: When shares in the Company are transferred (either during John’s lifetime or death) to both children.Purpose:To provide funds for Lawrence to “call” Jennifer’s shares, or for Jennifer to “put” her shares to Lawrence.
34 “When I go, I plan on taking at least two of my estate-tax lawyers with me.”