VAL - Part 2

Question 1

What problems may arise when a sole proprietor dies? 4

Answer 1

• Survivor Income - How will an income be continued to surviving family members?
• Debts - Will there be sufficient funds to pay the sole proprietor’s personal and business debts?
• Estate Settlement Costs - Will the executor or administrator have sufficient cash to pay estate taxes and other estate administrative costs required to settle the estate.
• Business Disposition - How can the value of the business interest best be preserved for the heirs?

Question 2

With planning, what can an insured buy-sell plan accomplish? 6

Answer 2

• A market for the sale of the sole proprietorship is created.
• The price at which the sole proprietorship will sell and the purchaser will buy the business is agreed upon in advance.
• The full purchase price is available exactly when needed at the sole proprietor’s death.
• The business is sold promptly and for its full market value, avoiding the losses associated with a forced liquidation.
• The value of the sole proprietorship may be fixed for federal estate tax purposes.
• Cash is available to settle the estate promptly and efficiently.

Question 3

What are the four methods a buy-sell plan be funded?

Answer 3

Cash - save up what is needed in full.
Installment Method - Price could be paid in installments after the death.
Loan Method - If possible the purchase price could be borrowed.
Insured Method - Only life insurance can guarantee that the cash needed is available, assuming valuation done accurately.

Question 4

When a key employee dies why might that cause a company to suffer financial loss? 5

Answer 4

• Reduction in Earnings
• Disruption of Management
• Replacement Costs
• Credit Problems
• Confidence Problems

Question 5

How could life insurance help prevent financial loss resulting from a death of a key employee? 6

Answer 5

• Indemnify your business for the permanent loss of the key employee’s skills and experience.
• Replace lost profits.
• Locate, hire and train a replacement.
• Provide a financial reserve during the adjustment period following the key employee’s death.
• Fund the purchase of a deceased shareholder’s ownership interest in the business.
• Provide benefits to the deceased employee’s family.

Question 6

What is the objective of business protection planning?

Answer 6

To assist in evaluating the impact that the death of disability of an owner or key employee could have on your business, and to help provide the funds that will be needed to protect your business from adverse financial consequences that car arise when an owner or key employee dies or becomes disabled.

Question 7

What issues can arise for the business around a deceased business owners heirs?

Answer 7

The heirs:

• Can become active in the business, even though they may be unqualified.
• They may even become owners of a controlling interest and be able to dictate corporate policy.
• They can remain inactive but look to the business for income, or
• They can sell their stock…to anyone with the purchase price.

Question 8

When an heir inherits a business ownership stake, what problems could arise? 3

Answer 8

• Need for income - They may need income, which can only come in the form of dividends from the corporation. Will this need for income conflict with the surviving shareholder’s salary expectations and desire to reinvest in the business?
• Estate liquidity - Will there be sufficient liquidity in the estate to pay taxes and other administrative costs without selling some portion of the stock, which may make up the majority of the estate?
• Market - Will there be a ready market for closely-held stock?

Question 9

How could the issues of an heir inheriting a share of a deceased’s business find a solution using life insurance?

Answer 9

Let the corporation and its shareholders enter into a binding stock redemption buy-sell plan that is funded with life insurance, the corporation will have the cash to purchase a deceased shareholder’s interest for a previously agreed-upon price that is fair to the heirs.

Question 10

What could an insured stock redemption buy-sell plan accomplish? 6

Answer 10

• The surviving shareholders avoid business problems associated with active or inactive heirs, while heirs receive cash instead of generally poor investment potential of closely held-stock.
• The corporation is committed to buy and the deceased shareholder’s estate is committed to sell the business interest for a price that is agreed upon in advance.
• The funds to complete the sale are available exactly when needed at a shareholder’s death.
• The value of the business interest may be fixed for federal estate tax purposes.
• The deceased shareholder’s heirs are guaranteed a full and fair cash price for the business.
• Cash becomes available to settle the deceased shareholder’s estate promptly and to replace family income.

Question 11

What are the common buy-sell agreements available using insurance? Incomplete Answer

Answer 11

• Insured Stock Redemption
• Insured Cross Purchase
• Partnership Insured Entity Purchase
• Partnership Insured Cross Purchase
• Add more

Question 12

If not prepared for, what happens to a partnership when one partner dies? Why is this an issue?

Answer 12

• The partnership no longer exists

- The surviving partners have no authority for the partnership, except for purposes of winding up its business affairs.

Question 13

When a partner dies and there is no plan do dispose of the business interest, what are the only two options available to the survivors?

Answer 13

• Reorganization

- Liquidation

Question 14

What is a Business Split-Dollar Life Insurance Plan?

Answer 14

Not an insurance policy, but when used by a business, is an arrangement that allocates life insurance policy benefits, and in some cases, premium costs between an employer and a valued employee.

Question 15

What are the two types of Split-Dollar Life Insurance Plans?

Answer 15

• Equity Split-Dollar Plan

- Non-Equity Split-Dollar Plan

Question 16

What is an Equity Split-Dollar Plan?

Answer 16

In this arrangement, the employee receives an interest in the policy’s cash value (equity) that is disproportionate to the employee’s share of the premiums payments, while the employer pays more of the premium. Typically, the party paying less (the employee) also receives the benefit of current life insurance protection.

Question 17

What is a Non-Equity Split-Dollar Plan?

Answer 17

In this arrangement, the employer typically provides the employee with current life insurance protection, but the employee has no interest in the policy’s cash value.

Question 18

Name the two regimes which determine how a split-dollar life insurance plan will be taxed.

Answer 18

• Economic Benefit Regime (Endorsement Split-Dollar Plan)

- Loan Regime (Collateral Assignment Split-Dollar Plan)

Question 19

Describe the Economic Benefit Regime (Endorsement Split-Dollar Plan)

Answer 19

The employer owns the life insurance contract, advances the money to pay premiums and provides economic benefits to the employee by allowing the employee to name a beneficiary for the policy’s death benefit by means of an endorsement to the life insurance contract.

The employee is then taxed on the value of the economic benefits received in each taxable year.

The endorsement method allows the policy’s cash value to be carried as a business asset and borrowed for business purposes (withdrawals and loans will reduce the policy’s death benefit and cash value available for use).

Question 20

Describe the Loan Regime (Collateral Assignment Split-Dollar Plan)

Answer 20

The employee owns the life insurance contract, names a personal beneficiary and assigns the policy as collateral to the employer, in return for the employer’s premiums payments. At the employee’s death, the employer receives a portion of the death benefit (usually equal to the total premiums it has paid) and the employee’s beneficiary receives the balance. If the policy is surrendered, the employer receives back the total premiums it has paid, up to the policy’s cash surrender value, and the employee receives any remaining cash surrender value.

The payments of premiums by the employer for a life insurance contract owned by the employee is treated as a series of loans to the employee. Unless the employee pays the employer market-rate interest on the loans, the employee is taxed each year on the difference between market-rate interest and the actual interest paid, if any.

Since the employer’s premium contributions are considered loans to the employee, federal and state laws should be checked to determine if there are any restrictions on corporate loans to employees, shareholders, officers, etc, before implementing a collateral assignment split-dollar plan. In addition, publicly-held corporations are strongly encouraged to consult their securities counsel on the potential impact of the Sarbanes-Oxley Act of 2002 on collateral assignment split dollar plans.

Question 21

What are the various Premium Sharing Variations on a split-dollar plan?

Answer 21

Employer Pay All Split-Dollar
Level Outlay Split-Dollar
Economic Benefit Split-Dollar (Endorsement Plan Only)
Bonus Split-Dollar (Endorsement Plan Only)
Bonus Split-Dollar (Collateral Assignment Plan Only)

Question 22

What are the features of a Split-Dollar Life Plan to the employer? 4

Answer 22

• The employer can select which employees will be covered by the plan and for what amounts.
• A business split-dollar life insurance plan requires no IRS approval.
• The employer can ultimately recover its premium outlays.
• A business split-dollar life insurance plan may help retain its valuable employees, since the benefit will be lost if the employee terminates employment.

Question 23

What are the features of a Split-Dollar Life Plan to the employee? 5

Answer 23

• The employee receives valuable life insurance protection at reduced or no out-of-pocket cost.
• Personal funds that might otherwise be spent on life insurance become available for other purposes.
• The employee’s personal beneficiary generally receives the death proceeds free of income tax.
• It may be possible to arrange the split-dollar life insurance plan so that death proceeds are not subject to tax.
• A split-dollar life insurance plan may be cost effective way for a shareholder-employee of a closely-held corporation to shift a portion of the cost of the owner’s personal life insurance to the corporation, if the corporation is in a lower tax bracket than the shareholder-employee.

Question 24

What is an Executive Bonus Plan?

Answer 24

A way to provide personal life insurance to selected key employees using fully-deductible business dollars that provides them with the benefit of life insurance coverage that only lasts while they are employed with the company.

Question 25

What are the two variations on Executive Bonus Plans?

Answer 25

• Standard Executive Bonus Plan

- Double Executive Bonus Plan

Question 26

What is the Standard Executive Bonus Plan?

Answer 26

The business pays the tax-deductible premiums for the life insurance policy and reports them as bonus to the selected key employee. The key employee then must pay the income tax due on this additional taxable income.

Question 27

What is the Double Executive Bonus Plan?

Answer 27

The business increases the tax-deductible bonus to cover both the premiums and the income tax due on the total bonus, meaning that the selected key employee has no additional out-of-pocket cost for this valuable employer-provided fringe benefit.