Do you want to transfer your business to your kids? Read this:
Mom or Dad wants to transfer the family business to one or more of the children. But the money to fund the buyout at the death of the parent/stockholder —insurance on the parent’s life — is in the wrong place.
Here’s a foolproof way of getting the job done, according to an IRS letter ruling:
The father, Joe, worked with his son, Sam, in a business founded by Joe. The stock of the corporation was owned 25 percent by Joe, 4 percent by Sam and the balance by five other children not active in the business.
Joe had two main objectives: First, to have his stock go to Sam after his death and, second, to make sure that his wife, Mary, would be financially secure for the rest of her life.
Joe and his son developed a plan to accomplish these objectives. They entered into a buy-sell agreement requiring Sam to buy his father’s shares from his estate after his death at fair market value. To fund the purchase, Sam would use the proceeds of a life insurance policy on his dad’s life.
The corporation owned the insurance policy and paid the premiums. Joe intended to buy the policy from the corporation for its cash-surrender value and gift the policy to his son. From then on, Sam would pay all premiums. Great news!
The IRS ruled that, under these conditions, Sam could collect the insurance proceeds income tax-free (IRS Letter Ruling 8906034).
There are two more tax goodies that flow as a result of this ruling.
One, when Sam buys Joe’s stock from his estate, the sale of the stock by the estate is income tax-free.
Why? Under the tax law, the estate gets a new tax basis equal to the stock’s fair market value at the date of Joe’s death.
Two, since Mary is the beneficiary of Joe’s estate, there is no estate tax. Why? An estate is entitled to a 100 percent marital deduction for all property passing to a spouse, Mary in this case.
What could be better? No income tax. No estate tax.
Sam owns 100 percent of Joe’s stock.
Mary is financially secure.
Perfect!
