Chapter 12

Question 1

Cross-Purchase Plans

Answer 1

Cross-Purchase Plans are agreements that provide that upon a business owner’s death, surviving owners will purchase the deceased’s interest, often with funds from life insurance policies owned by each principal on the lives of all other principals.

Question 2

Split-dollar plan (SDP)

Answer 2

A split-dollar plan (SDP) is a life insurance agreement that divides the costs and benefits of a policy between two or more parties. The parties sign a contract that specifies who owns the policy, who pays the premiums, and how the policy’s cash value, death benefit, and premium costs are split.
Split-dollar plans are often used for employee compensation and retention, or for estate planning. They can be effective when an employer wants to:
* Attract and retain top talent
* Protect the business from losing a key employee
* Offer incentives or deferred compensation to executives
Split-dollar plans are complex and should be set up with the help of financial and legal professionals.

Question 3

Deferred Compensation Plan

Answer 3

Deferred compensation plans are a way for employees to set aside a portion of their salary to be paid at a later date, usually when they retire. There are two types of deferred compensation plans: qualified and non-qualified.

Qualified plans
These plans meet the requirements of the Internal Revenue Code (IRC) Section 457(b) and the Employee Retirement Income Security Act (ERISA). They have tax advantages and are governed by agency rules. A 401(k) is an example of a qualified plan.

Non-qualified plans
These plans are governed by the employer and are often used to compensate specific employees or groups of employees. They can be cost-effective for employers, but employees can lose their money if the company goes bankrupt.

Tax deferral
Taxes on deferred income are usually deferred until the money is paid out, which can reduce the employee’s tax bracket for that year.

Question 4

Salary Continuation Plan

Answer 4

Salary Continuation Plan works the same as deferred compensation except that the employer funds the plan rather than the employee. The employer establishes an agreement whereby an employee will continue to receive income payments upon death, disability, or retirement.

Question 5

Corporate-owned Life Insurance

Answer 5

Corporate-owned life insurance (COLI) is generally treated as a deductible business expense. The proceeds are paid tax-free up to a certain level (i.e., $50,000). If more than this amount is provided to an employee, the excess premium used to purchase must be reported by the employee as taxable income.

Question 6

Corporate-owned Annuities

Answer 6

Contributions to a corporate annuity are taxed differently than individually owned annuities. A corporation must name a “natural person” as an annuitant if it owns an annuity. Sometimes, this natural person is called the “measurable life.” If a natural person is named as an annuitant, the interest credited to the annuity each year is generally not taxable (i.e., tax-deferred). If a non-natural entity is named an annuitant (i.e., the corporation), interest earned is taxable as ordinary income in the year credited.

Question 7

Executive Bonus Plan

Answer 7

Also referred to as a Section 162 bonus plan, an executive bonus plan is a non-qualified employee benefit arrangement. An employer pays a compensation bonus to a selected employee who uses the bonus payment to pay the premiums on a life insurance policy covering his or her life.

Question 8

Buy-sell agreement

Answer 8

A buy-sell agreement with life insurance is a contract that helps business owners plan for the transfer of ownership in the event of a triggering event, such as death, disability, retirement, or divorce:
Life insurance
A life insurance policy can fund the purchase of a deceased owner’s shares by providing a lump sum of cash to the remaining owners.

Buy-sell agreement
A buy-sell agreement is a contract that outlines the process for transferring ownership of a business interest.

Types of buy-sell agreements
There are two common types of buy-sell agreements:
Cross-purchase: Each owner buys a life insurance policy on the other owners and names themselves as the beneficiary.
Entity-purchase: The business buys separate life insurance policies on each owner.