Sources of Estate Liquidity Flashcards
1
Q
Estate Liquidity Defined
A
- an estate has adequate liquidity when the executor can convert assets in the estate into cash in the time required to meet the estate’s obligations, including:
- federal estate taxes, state death taxes, income taxes, income taxes, mortgage debt, and other debts and claims against the deceased.
- assets which are liquid are life insurance proceeds, checking and savings accounts, money market funds, CD’s and US Government securities.
2
Q
Techniques for improving estate liquidity for Closely Held Business Interests
A
- Buy-Sell Agreements
- Installment payment of taxes (sec. 6166)
- A stock redemption to pay taxes and expenses (sec. 303)
- Special Use Valuation (sec. 2032A)
3
Q
Buy-Sell Agreements
A
- contracts for the purchase and sale of a business interest in the event of an owners death, disability, or retirement.
- the estate will receive cash proceeds from the sale of the business interest, instead of an illiquid closely held business interest.
- the agreement establishes a price or pricing formula for the business interest, and if the agreement is written properly, this value will serve as the valuation of the business valuation for estate tax purposes.
4
Q
Buy-Sell for providing estate valuation
A
- the agreement must conform to the requirements of IRC code sec. 2703 (chapter 14), which requires:
- it must be a bona fide business agreement
- must not be a device to transfer the property to members of the decedent’s family for less than full or adequate consideration
- terms must be comparable to similar arrangements entered into by persons in an arm’s length transaction.
5
Q
Entity-Purchase Agreement
A
- provides for the corporation or partnership to buy the owner’s interest, and the owner commits to selling
- the business entity will buy life insurance on the owner.
- while the business interest will be included in the estate, the death benefits will not be
- if the agreement covers retirement, the entity can use the cash value of the life insurance policy to buy the business interest at the owner’s retirement.
6
Q
Entity Agreement - Avoiding Dividend Treatment (sec. 302)
A
- the danger arises in stock-redemption agreements if less than the entire amount of stock owned by the decedent is sold.
- If a complete redemption of the stockholders interest occurs, the transaction will be treated as a sale, rather than a dividend.
7
Q
Attribution Rules
A
- under the attribution rules even if the owner’s spouse owns no stock, the stock owned by other family members will be attributed to the spouse. Furthermore, if the spouse is the beneficiary of the estate, the stock of the family members will also be attributed to the estate.
- because of this even if the business redeemed all of the stock in the deceased estate, the transaction would only be partial redemption due to attribution rules.
- there is a 10-year waiver that allows for the treatment of a complete redemption as a sale, rather than a dividend. The rule requires that a stockholder’s entire interest be redeemed, and the stockholder must not acquire any interest for 10 years.
8
Q
Cross-Purchase Agreement
A
- the stockholder or partners buy insurance on eachothers interests.
- Each owner contracts their estate to sell their business interest, and each owner promises to buy the interests of the other owners.
- the surviving owners will typically buy the life insurance policies owned by the decedent on the other owners. At the time of their deaths, part of the proceeds from those policies may be subject to income tax under the transfer-for-value rule of the IRC, sec 101.
9
Q
First Offer Provision
A
-obligates the stockholders or partners to offer their business interest to the other owners before offering it to outsiders.
10
Q
Wait-and-See Provision
A
- the surviving owners will have the first offer to buy the shares under a cross-purchase agreement.
- If the surviving owners decline, they then have the option to implement a redemption.
- Can also be used in conjunction with a section 303 stock redemption, in which case the entity would purchase the shares being redeemed under the Section 303 redemption, then the surviving owners would be offered the remaining shares under a cross-purchase agreement.
11
Q
Comparing Cross Purchase and Entity Buy-Sells
A
- CP is more equitable when there is a substantial difference in ages
- if the ages and ownership interests are approximately equal, the Entity Agreement will probably be preferable because there will be fewer insurance policies.
- Under an entity approach, the purchase of the decedent’s interest does not change a surviving owner’s income tax basis in the stock or partnership interest
- with the CP,the purchase of the decedent’s interest adds to the tax basis for each surviving owner, resulting in a lower capital gain tax in the future for the surviving owner.
12
Q
Installment Payments - Sec 6166
A
- 35% or more of the decedents adjusted gross estate (excluding the state death tax deduction, if applicable) consists of a closely held business interest.
- can be a sole proprietorship, a partnership in which the decedent owned at least 20% of the capital interest or which had 15 or fewer partners, or a corporation in which the decedent owned at least 20% of the voting stock or which had 15 or fewer shareholders.
- several closely held business interest can be aggregated to meet the 35% requirement.
- 6166 allows for the payment of tax attributable to the closely held business interest in 10 equal installments.
- the first installment must be made within 5 years after the estate tax return is due.
- tax is deferred on the first 1.49 MM of a closely held business interest, the interest rate is only 2%
- If the business is larger than 1.49 MM then a rate of 45% higher than the 2% is used.
13
Q
Sec. 303 Redemption
A
- if a closely held corporation is 35% of the decedent’s gross estate, the estate can qualify
- Stock may be redeemed equal to the amount of all estate taxes, inheritance taxes, estate administration expenses, and funeral expenses.
- redemption will be treated as a sale rather than a dividend.
- redemption proceeds will not qualify if they are used to pay estate debts.
- if there are no estate tax liability and no administration expenses, this cannot be used.
14
Q
Incidents of Ownership for Life Insurance
A
- the right to name or change a beneficiary
- the right to surrender the policy for its cash value
- the right to borrow against the policy cash values
- the right to pledge the policy as collateral for a loan
- the right to assign the policy or to assign any of these named rights
- the right to revoke any assignment of the policy
- if at the time of death the decedent had any incidents of ownership the death benefit will be included in the estate.
15
Q
Survivorship Life Insurance
A
- useful to married couples who plan to take maximum advantage of the marital deduction, thereby deferring federal estate taxes until the death of the surviving spouse.
- Can be useful when one insured is older or is highly rated risk
