If you have an ownership interest in a business, life insurance can be an important tool to help ensure:
- There is money to pay estate taxes
- There is money to fund a buy-sell agreement
#1 Money to Pay Estate Taxes
As of 2019, the US Federal Estate Tax exemption is about $11 million which shields many taxpayers from estate taxes of 40% at death.
However, the estate tax is scheduled to sunset January 1, 2026, back to approximately $6 million, assuming there is not a “blue wave” in 2020 leading to legislation bringing the estate tax exemption to an even lower level.
Some readers may recall that not too long ago the estate exemption was $600,000 and almost every estate plan had “bypass trusts” for estate taxes!
If the estate tax exemption begins to fall then having life insurance money available on hand can ensure that your business does not have to make untimely liquidations to pay estate taxes at death.
For example, the estate tax (IRS Form 706) is due 9 months from date of death. What if your business value is locked up in illiquid assets? What if you own a series of rental properties and the real estate market is in a slump on your death? How much of your estate’s value would be lost if assets had to be sold at fire-sale prices?
2. Money to Fund a Buy Sell Agreement
Common issues with buy-sell agreements:
a. Who do you want to have an ownership interest in your business after you die?
b. Do those people need money to purchase that business interest from your estate after you die?
Example: For simplicity, imagine you are single and you want to leave your estate equally between your two children. Your estate is comprised primarily of a series of properties that Child 1 has been running for you as lead property manager for the last 10 years. You are asset rich but cash poor because you recently made a large property acquisition.
When you die, your children are now 50-50 owners of the business and they have deep disagreements on how the business should be run. For example, Child 1 is reluctant to sell the properties in a down real estate market but Child 2 is upset that the he is not receiving any cash from the business to help with his children’s college tuition. The conflict between the children lasts for years and causes long term damage to their relationship.
Life insurance on your life could prevent this conflict. You could buy enough life insurance on your life so Child 1 could receive the business and Child 2 could walk away with cash. The goal of this approach is to ensure each child receives an equal share of value without having to share management control over the business.
There are some disadvantages with this plan that may not make it work for all estate plans. For example, some clients may not wish to pay life insurance premiums or may find themselves uninsurable due to past health conditions.
This is just the tip of the iceberg when it comes to life insurance and business succession planning. If you would like help with your estate plan our attorneys at the Thrash, Carroll, Vanway Law Group would love to help. Schedule an appointment!
By Attorney, Chris Ha