Recently, the U.S. Supreme Court made a ruling about the wrong way to use life insurance when buying out the other owner’s family interest in the business upon the death of that owner.
Life insurance agents have loved to promote the idea of the company owning life insurance on each owner. Then upon the death of the owner, the company can buy out the family’s interest in the business.
There were two brothers who owned a small business together. They had purchased the life insurance on each and when one died in 2013, the proceeds from the life insurance was used to redeem the deceased shareholder’s shares. The life insurance was $3 million, per the redemption agreement. The deceased brother’s federal estate tax return reported the value of his shares at $3 million.
Along comes that mean old organization lovingly called the IRS. They said that upon the death of the brother, the life insurance proceeds increased the value of the company, which triggered estate taxes. The IRS said the value of the brother’s share of the company increased by the life insurance proceeds and thus valued the share at over $6 million. At that time, the estate tax exemption was $5 million, thus the brother’s estate owed $450,000 in estate tax.
The surviving brother was so incensed that he sued the IRS in U.S. District Court. He lost. Not to be discouraged, he appealed the decision to the U.S. Court of Appeals. He lost there too. Then, in final desperation, he took the case to the U.S. Supreme Court. The U.S. Supreme Court, on June 6, unanimously stated… the IRS was right! What? Oh, the betrayal. They agreed with the IRS! How could they?
Well, the moral of the story. Each brother should have taken out a life insurance policy on the other. Then at the date of death of the one brother, the proceeds could be used to buy out his family’s ownership in the business without triggering an increase in the value of the company.
So, if you currently have a buy-sell agreement that uses company-owned life insurance, you may want to work with your attorney to fix this.
Have you heard? Job 30:23 says, “For I know that you will bring me to death, to the house appointed for all living.”
Kelly Bullis is a Certified Public Accountant in Carson City. Contact him at 775-882-4459. On the web at BullisAndCo.com. Also on Facebook.