When enterprise house owners have companions and take into account their succession planning, the subject of a buy-sell settlement comes up. This put up discusses the potential use of an “insurance-only LLC” as a part of a buy-sell.
A buy-sell settlement units the phrases of a buyout of 1 associate by one other associate or companions if one associate leaves the enterprise. The buy-sell nearly at all times addresses the dying of a associate, and may tackle incapacity, retirement or different exit of a associate. A number of the key phrases in a buy-sell embody (1) what are triggering occasions for a buyout, (2) whether or not the buyout is obligatory or optionally available, (3) the phrases of the buyout (eg, all money, an unsecured observe, or a secured observe) and (4) the right way to worth the enterprise and set up the acquisition worth for the buyout.
It is not uncommon for enterprise house owners to buy life insurance coverage with the intention to fund a dying buyout. In a “cross buy” settlement, every proprietor owns a coverage on the opposite proprietor(s)’ lives and the buy-sell offers that the remaining proprietor(s) will buy the deceased proprietor’s fairness. In a “redemption” settlement, the corporate owns the life insurance coverage insurance policies and the buy-sell offers that the corporate will buy the deceased proprietor’s fairness.
Cross buy agreements are extra frequent than redemption agreements. Typically, in a redemption settlement, the customer doesn’t get a step-up in foundation, the coverage worth could also be uncovered to the collectors of the enterprise and there will be various minimal tax points. Alternatively, if there are a number of house owners, a conventional cross buy requires many insurance coverage insurance policies since every proprietor owns a coverage on all the opposite house owners.
A “trusteed buy-sell settlement,” is a cross-purchase settlement the place a belief is created to personal the life insurance coverage insurance policies. The belief owns one coverage on every proprietor, which solves the “a number of insurance policies” drawback. The trustee manages and maintains the insurance policies, which centralizes the administration of the association. There are, nonetheless, potential points with trusteed buy-sell agreements, similar to (1) whether or not the belief is a bona fide belief association (or is it extra precisely an escrow association), (2) how premiums are paid and allotted (particularly when there’s a substantial disparity within the premium quantities for the insurance policies), and (3) a possible transfer-for-value rule subject when the primary proprietor dies.
The “insurance-only” LLC is a possible resolution to the above points. The insurance-only LLC basically is a cross buy association the place an LLC is created to personal the life insurance coverage insurance policies on the enterprise house owners. The LLC has a third-party supervisor so there’s centralized administration of the group of insurance policies. The LLC elects to be handled as a partnership for tax functions. Normally, the working enterprise will make distributions to the house owners, they usually could make capital contributions to the LLC so the LLC pays premiums (this additionally could also be structured as a split-dollar association).
When one of many house owners dies, there are a number of steps. First, the LLC redeems the membership curiosity that was owned by the deceased member (ie, from the deceased member’s property). Then, the life insurance coverage proceeds are collected and distributed to the remaining members of the LLC. Lastly, the remaining members (eg, the opposite enterprise house owners) use the proceeds to buy the deceased enterprise proprietor’s fairness within the enterprise.
The insurance-only LLC thus solves sure points posed by a trusteed buy-sell settlement, together with how premiums are paid and the potential transfer-for-value rule points. Furthermore, the insurance-only LLC could also be structured so that every proprietor’s irrevocable insurance coverage belief is a member of the LLC relatively than the proprietor himself or herself, in order that the fairness bought from the deceased proprietor shouldn’t be included within the surviving house owners’ estates.
It ought to be famous that the association is technical to draft and never risk-free. The IRS has a “no rule” coverage on whether or not an insurance-only LLC shall be handled as a partnership for tax functions and whether or not the switch of insurance policies to the insurance-only LLC is exempt from transfer-for-value points. See, eg, Income Process 2022-3. Some state statutes on LLCs and LPs require a revenue motive for an entity. Planners additionally ought to take into account asset safety points, similar to whether or not a creditor might attain the property within the insurance-only LLC (treatments range amongst states) and whether or not a creditor of a deceased proprietor might attain the dying profit.
In sum, it is rather essential that enterprise house owners keep technically sound and up-to-date purchase promote agreements. The insurance-only LLC generally is a inventive method for a sophisticated buy-sell.