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Executive Trifecta ® for Key Executives. Executive Trifecta is a vital new concept in executive benefit planning. It can be used selectively for owner.

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Presentation on theme: "Executive Trifecta ® for Key Executives. Executive Trifecta is a vital new concept in executive benefit planning. It can be used selectively for owner."— Presentation transcript:

1 Executive Trifecta ® for Key Executives

2 Executive Trifecta is a vital new concept in executive benefit planning. It can be used selectively for owner or non-owner executives of C Corporations, S Corporations, Limited Liability Companies, and Partnerships.

3 Most firms would not consider operating without insuring against the loss of its property. The same logic should apply to its human capital -- a far more vital asset to the successful continuation of any business. Background

4 If an executive is valuable enough to have life insurance coverage to indemnify the business, that individual should also be provided with unique executive fringe benefits. The reverse is also true -- Background If an executive is valuable enough to be provided with unique executive fringe benefits, that individual should also have life insurance coverage to indemnify the business. Too often, one is provided without regard for the other – and the fusion of both concepts can be dynamic.

5 Selected key executives are insured in favor of the employer; In pre-retirement years, a portion of each policys death benefit is allocated to provide survivor income benefits to the insured executives family; At each key executives retirement, disability, or involuntary severance without cause, the life insurance policy is contractually transferred to the executive (as a deferred bonus) thereby creating a supplemental retirement asset. Trifecta refers to a winning sequence of three -- and Executive Trifecta delivers three, very powerful, sequential benefits:

6 The reasons to allocate a portion of the policys pre- retirement death proceeds for the benefit of the employer are as follows: Recover the loss of profits while a replacement gets up to speed; Recover the costs of locating a replacement; Assure creditors and suppliers that loans and receivables are safe; Recover the permanent loss of profits if the executive is "irreplaceable"; Assure customers that the business will continue its operations; Fund a buyout if the executive is a shareholder. Recover the costs of a signing bonus; Recover the costs of a relocation package;

7 Provide an inexpensive source of continuing family income; The reasons to allocate a portion of the policys pre- retirement death proceeds for the benefit of the executives family are as follows: Provide the executive with relief from purchasing expensive personal life insurance coverage.

8 Provide the executive with after tax retirement cash flow by way of policy withdrawals and/or loans; The reasons to transfer ownership of the policy to the executive at retirement are as follows: Provide income tax free death benefits for the executives family.

9 Basic Variation Key Executive Coverage With the Basic Variation, the user inputs the amount of life insurance coverage to indemnify the employer against the loss of the key executive under the modules Key Executive Coverage tab. This provides much simpler data entry when that amount is known in advance (e.g., stock redemption coverage or a client- designated number).

10 Advanced Variation Key Executive Coverage With the Advanced Variation, the System calculates the amount of life insurance coverage used to indemnify the employer against the loss of the key executive. This is done via user-entered estimates as to how long it will take a replacement executive to match the performance of the deceased executive. The System also calculates differences in expected compensation between the two executives.

11 Basic and Advanced Variations Survivor Income Benefit and Policy Transfer With either Variation, the System calculates the amount of coverage to fund the survivor income benefit as well as the tax details of the transfer of the policy to the participant at retirement (or at an earlier date such as achieving specific sales, revenue, or profit goals).

12 Shareholder -- C Corporation Shareholder -- S Corporation Member -- Limited Liability Company Partner -- Partnership Non-Shareholder Executive -- C Corporation Non-Shareholder Executive -- S Corporation Non-Member Executive -- Limited Liability Company Non-Partner Executive -- Partnership Tax Notes Click on the Blue buttons for direct access or continue through the participant examples one screen at a time. Balance of the Presentation Main Menu (Illustration Data)

13 At retirement, the Corporation distributes the policy as compensation. The executive has taxable income to the extent of the policys fair market value -- which is its cash value without reduction for surrender charges (IRS Rev. Proc ). The Corporation must recognize any gain to the extent that the cash value of the policy exceeds the Corporations premium payments; however, the Corporation is entitled to a deduction under IRC Section 162 equal to the amount the executive includes in income. Executive Trifecta Shareholder Executive of C Corporation Note: The personal taxation is the same for a non-shareholder executive.

14 Click here to review the illustration. Ferris Metallurgicals pre-retirement annual premium: $25,000 Ferris Metallurgicals pre-retirement death benefit: $1,529,322 Portion allocated for loss of Toms services: $1,000,000 Portion allocated for survivor benefit for Toms family: $529,322 Toms pre-retirement survivor benefit: $100,000 a year for 10 years Toms income tax when policy is transferred: $382,785 Toms policy withdrawal to pay the tax: $382,785 Toms post-retirement annual premium: $0 Toms personal death benefit starting at age 65: $1,000,000+ Toms tax free retirement cash flow at age 65: $61,000 for 20 yrs. Results for Tom Cabot, Age 45, a Key Shareholder Executive of Ferris Metallurgical, Inc. (C Corporation) Main Menu ->

15 At retirement, the S Corporation distributes the policy to the Shareholder as a K-1 distribution, and any gain is recognized by the Corporation as if the property were sold at fair market value - - which is its cash value without reduction for surrender charges (IRS Rev. Proc ). The gain passes through to the Shareholder as ordinary income under the built-in gains rules (IRC Secs. 311(b), 1366(a)(1) and 1374). In other words, a Shareholder of an S Corporation pays income tax only on the gain in the policy -- not on the entire cash value as is the case with a C Corporation. The Shareholders basis in the policy is its cash value on the date of transfer without reduction for surrender charges. Executive Trifecta Shareholder Executive of S Corporation

16 Click here to review the illustration. Advantis Softwares pre-retirement annual premium: $25,000 Advantis Softwares pre-retirement death benefit: $1,529,322 Portion allocated for loss of Joes services: $1,000,000 Portion allocated for survivor benefit for Joes family: $529,322 Joes pre-retirement survivor benefit: $100,000 a year for 10 years Joes income tax when policy is transferred: $201,848 Joes policy withdrawal to pay the tax: $201,848 Joes post-retirement annual premium: $0 Joes personal death benefit starting at age 65: $1,200,000+ Joes tax free retirement cash flow at age 65: $80,000 for 20 yrs. Results for Joe Mason, Age 45, a Key Shareholder Executive of Advantis Software, Inc. (S Corporation) Main Menu ->

17 Executive Trifecta Member of Limited Liability Company When the LLC distributes the policy to the Member as a K-1 distribution at retirement, no gain or loss need be recognized by the LLC on a distribution of property or money to a Member (IRC Sec. 731(b)). Likewise, no gain or loss need be recognized by the Member receiving the policy, regardless of whether the value of the policy is higher or lower than the Members adjusted basis in the Members interest in the Company (IRC Sec. 731(a)).

18 Click here to review the illustration. Scott Engineerings pre-retirement annual premium: $25,000 Scott Engineerings pre-retirement death benefit: $1,529,322 Portion allocated for loss of Harveys services: $1,000,000 Portion allocated for survivor benefit for Harveys family: $529,322 Harveys pre-retirement survivor benefit: $100,000 a year for 10 years Harveys income tax when policy is transferred: $0 Harveys policy withdrawal to pay the tax: N/A Harveys post-retirement annual premium: $0 Harveys personal death benefit starting at age 65: $1,400,000+ Harveys tax free retirement cash flow at age 65: $100,000 for 20 yrs. Results for Harvey Scott, Age 45, a Key Member of Scott Engineering, LLC (Limited Liability Company) Main Menu ->

19 When the Partnership distributes the policy to the Partner as a K-1 distribution at retirement, no gain or loss need be recognized by the Partnership on a distribution of property or money to a Partner (IRC Sec. 731(b)). Executive Trifecta Partner of Partnership Likewise, no gain or loss need be recognized by the Partner receiving the policy, regardless of whether the value of the policy is higher or lower than the Partners adjusted basis in the Partners interest in the Partnership (IRC Sec. 731(a)).

20 Click here to review the illustration. BS&Cs pre-retirement annual premium: $25,000 BS&Cs pre-retirement death benefit: $1,529,322 Portion allocated for loss of Jeremys services: $1,000,000 Portion allocated for survivor benefit for Jeremys family: $529,322 Jeremys pre-retirement survivor benefit: $100,000 yr. for 10 yrs. Jeremys income tax when policy is transferred: $0 Jeremys policy withdrawal to pay the tax: N/A Jeremys post-retirement annual premium: $0 Jeremys personal death benefit starting at age 65: $1,400,000+ Jeremys tax free retirement cash flow at age 65: $100,000 for 20 yrs. Results for Jeremy Baker, Age 45, a Key Partner of Baker, Simms, and Caldwell (BS&C) (Partnership) Main Menu ->

21 C Corporation: At retirement, the policy is distributed to the participating non-shareholder executive as compensation. The executive has taxable income to the extent of the policys fair market value -- which is generally approximated by the policys cash value without reduction for surrender charges (IRS Rev. Proc ). Note: A non-shareholder executive of a C Corporation has identical personal taxation as a non-owner executive of any other type of business. In the year of policy distribution, the Corporation must recognize any gain to the extent that the cash value of the policy exceeds the Corporations premium payments; however, the Corporation is entitled to a deduction under IRC Section 162 equal to the amount the executive includes in income. Executive Trifecta Illustrations Taxation: Non-Shareholder Executive

22 Click here to review the illustration. Ferris Metallurgicals pre-retirement annual premium: $25,000 Ferris Metallurgicals pre-retirement death benefit: $1,529,322 Portion allocated for loss of Marks services: $1,000,000 Portion allocated for survivor benefit for Marks family: $529,322 Marks pre-retirement survivor benefit: $100,000 a year for 10 years Marks income tax when policy is transferred: $382,785 Marks policy withdrawal to pay the tax: $382,785 Marks post-retirement annual premium: $0 Marks personal death benefit starting at age 65: $1,000,000+ Marks tax free retirement cash flow at age 65: $61,000 for 20 yrs. Results for Mark Fox, Age 45, a Key Non- Shareholder Executive of Ferris Metallurgical, Inc. (C Corporation) Main Menu ->

23 S Corporation: At retirement, the policy is distributed to a participating non-shareholder executive as compensation. The executive has taxable income to the extent of the policys fair market value -- which is generally approximated by the policys cash value without reduction for surrender charges (IRS Rev. Proc ). Note: A non-shareholder executive of an S Corporation has identical personal taxation as a non-owner executive of any other type of business. In the year of policy distribution, all shareholders are entitled to a deduction equal to their proportionate share of the distributed policys fair market value, and any gain will pass through to the shareholders pro rata as ordinary income under the built-in gains rules (IRC Secs. 311(b), 1366(a)(1) and 1374). Executive Trifecta Illustrations Taxation: Non-Shareholder Executive

24 Click here to review the illustration. Advantis Softwares pre-retirement annual premium: $25,000 Advantis Softwares pre-retirement death benefit: $1,529,322 Portion allocated for loss of Bruces services: $1,000,000 Portion allocated for survivor benefit for Bruces family: $529,322 Bruces pre-retirement survivor benefit: $100,000 a year for 10 years Bruces income tax when policy is transferred: $382,785 Bruces policy withdrawal to pay the tax: $382,785 Bruces post-retirement annual premium: $0 Bruces personal death benefit starting at age 65: $1,000,000+ Bruces tax free retirement cash flow at age 65: $61,000 for 20 yrs. Results for Bruce Michaels, Age 45, a Key Non- Shareholder Executive of Advantis Software, Inc. (S Corporation) Main Menu ->

25 Limited Liability Company: At retirement, the policy is distributed to the participating non-member executive as compensation. The executive has taxable income to the extent of the policys fair market value -- which is generally approximated by the policys cash value without reduction for surrender charges (IRS Rev. Proc ). Note: A non-member executive of a Limited Liability Company has identical personal taxation as a non-owner executive of any other type of business. In the year of policy distribution, all members are entitled to their proportionate share of a deduction equal to the distributed policys fair market value. Executive Trifecta Illustrations Taxation: Non-Member Executive

26 Click here to review the illustration. Scott Engineerings pre-retirement annual premium: $25,000 Scott Engineerings pre-retirement death benefit: $1,529,322 Portion allocated for loss of Alans services: $1,000,000 Portion allocated for survivor benefit for Alans family: $529,322 Alans pre-retirement survivor benefit: $100,000 a year for 10 years Alans income tax when policy is transferred: $382,785 Alans policy withdrawal to pay the tax: $382,785 Alans post-retirement annual premium: $0 Alans personal death benefit starting at age 65: $1,000,000+ Alans tax free retirement cash flow at age 65: $61,000 for 20 yrs. Results for Alan Johnson, Age 45, a Key Non- Member of Scott Engineering, LLC (Limited Liability Company) Main Menu ->

27 Partnership: At retirement, the he policy is distributed to a participating non-partner executive as compensation. The executive has taxable income to the extent of the policys fair market value -- which is generally approximated by the policys cash value without reduction for surrender charges (IRS Rev. Proc ). Note: A non-partner executive of a Partnership has identical personal taxation as a non-owner executive of any other type of business. In the year of policy distribution, all partners are entitled to their proportionate share of a deduction equal to the distributed policys fair market value. Executive Trifecta Illustrations Taxation: Non-Partner Executive

28 Click here to review the illustration. BS&Cs pre-retirement annual premium: $25,000 BS&Cs pre-retirement death benefit: $1,529,322 Portion allocated for loss of Teds services: $1,000,000 Portion allocated for survivor benefit for Teds family: $529,322 Teds pre-retirement survivor benefit: $100,000 a year for 10 years Teds income tax when policy is transferred: $382,785 Teds policy withdrawal to pay the tax: $382,785 Teds post-retirement annual premium: $0 Teds personal death benefit starting at age 65: $1,000,000+ Teds tax free retirement cash flow at age 65: $61,000 for 20 yrs. Results for Ted Coombs, Age 45, a Key Non- Partner of Baker, Simms, and Caldwell (BS&C) (Partnership) Main Menu ->

29 Click here to review Tax Notes regarding: Main Menu -> Tax details of the plan for various business entities (C Corp, S Corp., LLC, Partnership) based on a participants relationship to those entities; Suitability of the plan based on the type and size of a business. Note: Transfer taxation for shareholders of an S Corporation is different based on the number of shareholders participating in the plan. Be sure to review Sections 2a, 2b, and 2c of the Tax Notes file for details (including the Notes that follow Section 2c). Tax Notes

30 Excess Compensation Shareholder Executive of a C Corporation: Executive Trifecta can produce substantial cash values for this participant at the point the policy is transferred to the executive. Such sums should not necessarily trigger excess compensation because the agreement to transfer would likely have been in effect for many years and therefore covers many years of service. A clients legal and tax counsel should be specifically consulted on this issue. Excess compensation should not an issue for pass-through entities such as S Corporations, Limited Liability Companies, and Partnerships.

31 Policy Death Benefit Prior to the distribution of the policy to the insured participant, the entire death benefit of the policy funding an Executive Trifecta arrangement is payable to the business entity in order to provide it with funds to 1) indemnify the business against the loss of services of the insured participant and 2) informally fund the payment of a Survivor Income Benefit to the insured participants family. The policy death benefit received should be income tax free to the business entity under IRC Section 101(a) provided that the appropriate notice and consent documents have been executed as required by IRC Section 101(j)(4) as well as the reporting requirements required by IRC Section 6039I.

32 Policy Death Benefit (continued) The notice and consent requirements of IRC Sec. 101(j)(4) are met if, before the life insurance policy is issued, the employee: is notified in writing that the employer intends to insure the employees life and the maximum face amount of the coverage at the time the coverage is issued; gives written consent to being insured under the contract and continuation of such coverage after the insured employee terminates employment; and is informed in writing that the employer will be a beneficiary of death proceeds from the policy.

33 Policy Death Benefit (continued) With respect to IRC Section 6039I, an employer that, after August 17, 2006, has one or more employer-owned life insurance contracts must file a return that shows for each year the policy is owned: the number of employees employed at the end of the year; the number of employees insured under employer-owned life insurance contracts at the end of the year; the total amount of insurance in force under such contracts at the end of the year; the name, address, and taxpayer identification number of the employer and the type of business in which the employer is engaged; and that the employer has a valid consent for each insured employee.

34 A specimen Company-Owned Life Insurance - Notice and Consent Form (as required by IRC Section 101(j)) and a specimen Company-Owned Life Insurance - Annual Reporting Form (as required by IRC Section 6039I) are in the Executive Trifecta document set and in the Special Files section of InsMarks Documents On A Disk and Documents On The Net Systems (Versions 17.0 and higher). Policy Death Benefit (continued) Record Keeping Requirement – Any employer (or other applicable policyholder) that owns one or more employer-owned life insurance contracts during the year must keep whatever records are necessary to determine whether the requirements of the IRC Sections 6039I and 101(j) are met.:

35 Policy Death Benefit (continued) Regardless of the business entity, the Survivor Income Benefit paid to an insured participants family when the insured dies prior to distribution of the policy should be deductible by the business when paid (IRC Sec. 404(a)(5)) and taxable as ordinary income to the recipient(s). The survivor benefits are subject to tests of reasonable compensation (IRC Sec. 162). Note re Shareholders of S Corporations, Members of Limited Liability Companies, and Partners of Partnerships: Legal and tax advisers may find it advantageous to treat the death benefit proceeds allocated for the survivor income benefit as a lump sum K-1 distribution.

36 Policy Death Benefit (continued) After the policy is transferred to the insured (typically at retirement), any subsequent death benefit payable to that participants beneficiaries should be income tax free under IRC Section 101(a).

37 Retirement Cash Flow After policy ownership is transferred to the insured (typically at retirement), any withdrawals of cash values or dividends from the policy by the participant should be income tax free to the extent they do not exceed the insureds basis. Any policy loans should also be income tax free (provided the policy stays in force).

38 Illustration Resources Licensees for Version 15.0 (and higher) of the InsMark Illustration System can review all the menu input for the Executive Trifecta illustrations in this presentation by double clicking on the file named Executive Trifecta (PPT).!II located in the following directory of your computer: C:/insmark/workbook Close this presentation before launching that file. If you are not licensed for the InsMark Illustration System, call InsMark at InsMark ( ) for licensing information.

39 Specimen documentation for Executive Trifecta can be found in Version 17.0 of InsMarks Documents On A Disk ® (DOD) System and Documents On The Net ® System (DON). The InsMark Illustration System has a link to these documents on the lower right side of the Workbook window (when in Edit mode in the Executive Trifecta module). Version 18.0 of DOD and DON (due for release in the 2nd Quarter of 2008) has more comprehensive documentation for S Corporations, Limited Liability Companies, and Partnerships. If you are a user authorized to receive Version 18.0 and would like copies of such documentation prior to the release, contact InsMark at InsMark ( ). If you are not licensed for either DOD or DON, call InsMark at InsMark ( ) for licensing information. Specimen Documentation

40 IRC Section 409A Executive Trifecta falls under the purview of IRC Section 409A; however, provided the plan is properly designed, documented, and administered, there should be no adverse affects relative to Sec. 409A that should apply. Executive Trifecta works because, even though it may fail the substantial risk of forfeiture test and be characterized as deferred compensation under IRC Section 409A, it meets the election and distribution requirements of Section 409A, thus allowing for deferral of income.

41 IRC Section 409A (continued) Under the regulations, it appears that a plan may fail to have a substantial risk of forfeiture under Section 409A but have a substantial risk of forfeiture under IRC Section 83, thus being deferred compensation for income tax purposes but a welfare plan for ERISA purposes. Unless the IRS provides future guidance to the contrary, Executive Trifecta would be deemed to have a substantial risk of forfeiture for Section 83 and ERISA purposes, and the plan would meet the deferred compensation requirements of Section 409A.

42 Sarbanes-Oxley Act Since Executive Trifecta does not involve loan funding of premiums, it is unaffected by the provisions of Sarbanes-Oxley that prohibit loan-based split dollar. Consequently, it is available for executives of publicly-owned companies as well as private ones. Split Dollar Executive Trifecta has no split dollar features and should be unaffected by the U. S. Treasury Departments Final Split Dollar Regulations issued in September 2003.

43 C Corporation: A C Corporation can retain its net profits as operating capital or merely to strengthen the balance sheet; however, a C Corporation is taxed at the corporate level on net profits. If net profits are then distributed as dividends, the shareholder(s) are again taxed. If all net after tax profits are distributed, there are no funds left to provide the Executive Trifecta for anyone, and it is unlikely that such a C Corporation can utilize Executive Trifecta. The ideal C Corporation candidate for Executive Trifecta is one that requires a strong balance sheet and therefore retains a portion of net profits. Suitability - Type of Business

44 S Corporation, Limited Liability Company, Partnership: These pass-through entities, like C Corporations, can decide to retain net profits as operating capital or merely to strengthen the balance sheet. However, all profits are considered as if they were distributed to shareholders, members, or partners, as the case may be, and are income taxable to those individuals. As a result, most pass-through entities distribute at least an amount of net profits to cover the income tax. If the remaining net profits are also distributed, there are no funds left to provide the Executive Trifecta benefit for anyone. The ideal pass-through entity candidate for Executive Trifecta is one that retains a portion of net profits. Suitability - Type of Business (continued)

45 With standard deferred compensation arrangements, there may be a concern that a business may not survive the death of its owner(s) resulting in an absence of the continuity of management needed to fulfill retirement income commitments. With Executive Trifecta, the policy values that fund the insured participants retirement cash flow are generated from a life insurance policy that has been contractually transferred to that participant, and the continuation of the business thereafter is irrelevant to that cash flow. Suitability - Size of Business

46 Continuity of management concerns can be avoided with the survivor income benefit associated with Executive Trifecta by scheduling the payment to the insureds family in a lump sum. Note: Legal and tax advisers may find it advantageous to treat the death benefit proceeds allocated for the survivor income benefit as a lump sum K-1 distribution for principals of S Corporations, Limited Liability Companies, and Partnerships.) Suitability - Size of Business (continued)

47 Important Notice Examples and case studies are for illustration purposes. Actual results may vary. Legal and tax information is for general use only and may not be applicable to specific circumstances. Clients should consult their own legal, tax and accounting advisors to assist in the evaluation of any potential transaction or strategy. Policy loans reduce policy cash values and death benefits, and the lapse of a loaned policy could result in severe tax ramifications to the policy owner. Be sure to consult a professional tax adviser if you have questions about this.

48 Circular 230 Disclosure In order to ensure compliance with requirements imposed by the IRS under Circular 230, any U.S. Federal tax advice or information contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any matters addressed herein.

49 Circular 230 Disclosure (continued) In the event that this document (including any attachments, enclosures, or referred material) is also considered to be a marketed opinion within the meaning of the IRS guidance, then, as required by the IRS, please be further advised that the material contained herein is written to support the promotions or marketing of the transactions or matters addressed by the material contained herein, and, based on the particular circumstances, you should seek advice from an independent tax adviser.

50 Copyright , InsMark, Inc. All Rights Reserved Clip art may not be reused without written authorization from its owner. Click here for the Main Menu. Click here to start from the beginning. Click here to end this presentation. InsMark, Executive Trifecta, and Documents On A Disk are registered trademarks of InsMark, Inc.


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