Case Scenario
Bruce, Tom, Pat, and Michele are four equal owners of their company, Albatross, Inc., an LLC, taxed as partnership. Their company specializes in managing the wildlife on private and public golf courses. Over the years, as golf has become more popular, their business has grown dramatically. Each of them has expressed their desire to make sure their respective spouse receives the value of their stock should one of them die. Additionally, the surviving owners wish to reduce any future capital gains tax should one of them desire to sell their shares. As a group, the owners have also discussed the desire for the surviving owners to continue to own the business without any interference from a deceased owner’s family members.
Their Goals
- Allow the surviving spouse of a deceased owner to receive the financial value of Albatross, Inc. stock.
- Reduce future capital gains tax for surviving owners should they decide to sell.
- Make certain that surviving owners can own the business without interference from a deceased owner’s family members.
about the future of a business
and what may happen after
the death of a shareholder.
By planning ahead, strategies
may help the business to
continue to thrive.
A Possible Solution
Bruce, Tom, Pat, and Michele understand that a traditional life insurance funded cross-purchase buy-sell arrangement will solve most of their objectives, but they realize that a traditional cross-purchase buy-sell arrangement with four owners would require 12 life insurance policies; much too many to administer.
They met with their financial professional who came up with a possible solution to their situation – a trusteed cross-purchase buy-sell arrangement. In a trusteed cross-purchase buy-sell arrangement, Bruce, Tom, Pat, and Michele establish a revocable trust naming a third party as trustee. The trustee becomes the owner and beneficiary of one policy on the life of each of them. This reduces the number of policies needed to fund the buy-sell from 12 to four. Bruce, Tom, Pat, and Michele would contribute funds to the trust to pay premiums, which would allow the trustee to pay the premiums on the policies as they come due. If Tom were to die first, for example, the trustee would collect the insurance proceeds and distribute them to Bruce, Pat, and Michele. They would now have the funds with which to purchase the stock from Tom’s estate, as required by a separate cross-purchase buy-sell agreement. The trustee will then distribute Tom’s ownership interest equally to Bruce, Pat, and Michele. In the alternative, the trustee can distribute the insurance proceeds to Tom’s estate in exchange for his ownership interest.
Disadvantages of Using a Trusteed Cross-Purchase Arrangement
A disadvantage to the trusteed cross-purchase buy-sell strategy is the potential transfer-for-value (TVF) issue. A TFV issue can arise after the death of an owner where the deceased owner’s beneficial interests in the policies on the lives of the other owners pass to the surviving owners. Arguably, this could constitute a TFV. Considering the TFV issue1, when implementing this strategy, the business owners should also be partners with each other in a bona fide partnership. In this situation, since Albatross, Inc., is taxed as a partnership, any transfers of a beneficial interest in a life insurance policy will generally be considered as an exception from the TFV rule.
Advantages of Using a Trusteed Cross-Purchase Arrangement
In addition to minimizing the number of life insurance policies needed to fund a cross-purchase arrangement, the trusteed arrangement ensures that the surviving owners will get an increase in basis in the ownership they purchase. A trusteed arrangement also ensures that there is specific performance of the buy-sell agreement in that the proceeds from the insurance policy are distributed to the decedent’s estate in exchange for the ownership interest.
Trusteed Cross-Purchase Arrangement
How it Works During Life
How it Works Upon Death
- 1 Certain transfers of life insurance contracts may jeopardize the income tax free payment of the death proceeds (above basis in the contract). The client should always consult their tax and legal advisors prior to making any changes to ensure that the transfer either is not a transfer-for-value or meets one of the exceptions to the transfer-for-value rule and thus the death benefit will still be received income tax free.
Participating whole life insurance policies are issued by Massachusetts Mutual Life Insurance Company (MassMutual), Springfield, MA 01111-0001.
- The information provided is not written or intended as specific tax or legal advice. MassMutual, its subsidiaries, employees, and representatives are not authorized to give tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel.
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