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					   The Role of Life Insurance
in Business Succession Planning




   Julius H. Giarmarco, Esq.
                Family Facts
Father:      John (age 65)
Mother:      Mary (age 65)
Son:         Lawrence (age 35)
Daughter:    Jennifer (age 30)

Ø Lawrence is only child active in the family
  business
Ø Lawrence has 3 children and Jennifer has 2
  children.
      John & Mary’s Balance Sheet
                                                               Value
  Residence (Joint)                                       $1,000,000
  Vacation Home (Joint)                                     $750,000
                                                                     1
  Business (S corp) (John)                                $5,000,000
  Building (LLC) (John)                                   $2,000,000
  Non-Qualified Investments (Joint)                         $500,000
  IRAs (John)                                               $750,000
  Life Insurance (John)                                          -0-
  Gross Estate                                           $10,000,000

1. Cost basis of $500,000; Assume 10% dividend and 4% principal appreciation.
      John & Mary’s Objectives
1. Retain control of the S corporation until
     retirement.
2.   Pass the entire business to Lawrence at
     John’s death.
3.   Retain one or two key-employees to
     assist in the transition period
4.   Treat children fairly.
5.   Guarantee retirement income.
6.   Reduce or eliminate estate taxes.
Projected Estate Tax Liability in 2028
   No federal            Current Net Estate              $20,736,000
estate taxes and         Existing Life Insurance                 -0-
expenses at first        Total Estate                    $20,736,000
     death


       By-Pass Trust and                  Estate of
        Other Transfers               Surviving Spouse
          $3,500,000                    $17,236,000



                             After Tax Estate      Federal Taxes
                              $11,054,800           $6,181,200
                                                      29.8%



                                    Distribution to Heirs
                    After Tax Estate                          $11,054,800
                    By-Pass Trust and Other Transfers           3,500,000
                    Total                                     $14,554,800

                              Distribution to Family: 70.2%
 Assumes 4% growth through 2028.
 Assumes the estate tax exemption is $3.5M and the estate tax rate is 45%.
   Options to Pay the Estate Tax if
      John & Mary Do Nothing
1. Good - IRC Section 6166 (5 year deferral;
            10 year installment payment of
            estate tax)
2. Better - IRC Section 303 (redemption of
            stock to pay death taxes)
3. Best - Irrevocable Life Insurance Trust
           Discounted dollars
           Can purchase assets from estate
           Can loan monies to estate
 Section 303 Redemption
  During John’s Lifetime
                                      Insurance
                                       Company


                         Pays Premiums

            S Corp


          Obtains Life
           Insurance            • If stock interest is
 John                             more than 35% of
                                  adjusted gross
Insured                           estate, the estate
                                  will qualify for a
                                  partial redemption.
Section 303 Redemption
  Upon John’s Death
                                             Insurance
                                              Company
                                    Pays Death Benefits


                     S Corp

                             Cash
                                        • Partial redemption is
John                                      not treated as a
                                          dividend.
 Stock Passes
                Some Stock              • Family continues to
                                          retain an ownership
                     John’s
                                          interest.
                   Living Trust
 Advanced Techniques to Transfer
      Business to Lawrence
     During John’s Lifetime

1. Private Annuity Sale
2. Self Canceling Installment Note (“SCIN”)
3. Grantor Retained Annuity Trust
4. Installment Sale to Grantor Trust
5. Charitable Stock Bail Out
           Private Annuity Sale
§7520 Rate                                     5%
FMV of S Corporation                    $5,000,000
John’s Basis                              $500,000
Payment Period                              Annual
Initial Annual Payout                     $473,979
Single Life Expectancy (Age 65)           20 Years
Capital Gain Realized at Time of Sale   $4,500,000

Initial Annuity Payment Breakdown
         Tax-Free Portion                $256,410
         Ordinary Income Portion         $217,568
          Bullet Proofing the
         Private Annuity Sale
Ø John should consider funding an ILIT (for
  the benefit of Mary) to “replace” the
  annuity payments in the event of his
  premature death.
Ø Lawrence should consider purchasing
  life insurance to provide the funds
  necessary to continue the annuity
  payments should be predecease his
  father.
Self Canceling Installment Note
§7520 Rate                                       5%
FMV of S Corporation                     $5,000,000
Cost Basis                                 $500,000
Initial Down Payment                              $0
Term of Note                               19 Years
Type of Note                           Interest Only
No-Risk-Premium Market Interest Rate             5%
Payment Period                               Annual
 Self Canceling Installment Note
                                          Risk Premium
                                      Principal     Interest
Mortality Risk Premium (Principal)   $2,619,628          N/A
Total Sale Price                     $7,619,628   $5,000,000
Principal Amount of Note             $7,619,628   $5,000,000
Mortality Risk Premium (Interest)           N/A     3.5620%

Annual Principal Payments                    $0           $0
Annual Interest Payments               $380,981     $428,083
Balloon Payment at the End of Note   $7,619,628   $5,000,000
Total Interest to be Paid            $7,238,646   $8,133,577
Total Capital Gain                   $7,119,628   $4,500,000
       Bullet Proofing a SCIN
John should consider funding an ILIT (for
the benefit of Mary) to “replace” the note
payments in the event of his premature
death.
                 GRAT
           Trust Established

   John         Transfers       GRAT
                S Stock

                (can be
Pays Gift Tax
                arranged with
                no gift tax)




   IRS
                 GRAT
           During GRAT Term

     John
(pays taxes on        Pays           GRAT
 trust income)       Annuity




 IF JOHN DIES BEFORE END OF TRUST TERM

                                      GRAT
                               (portion of property
John’s Estate
                                subject to estate
                                      taxes)
             GRAT
      At End of GRAT Term

If John lives to end of    GRAT
trust term, property in
GRAT is not subject to
estate taxes.             Remainder
                           Paid to




                          Lawrence
 Grantor Retained Annuity Trust
§7520 Rate                                                  4.40%
John’s Age                                                      65
Income Earned by Trust                                     10.00%
Annual Growth of Principal                                  5.00%
Term/Number of Payments                                         10
Pre-discounted FMV                                     $5,000,000
Discounted FMV                                         $3,000,000
Annual Percentage Payout                               16.66000%

        Beginning      5.00%      10.00%      Annual
  Year   Principal     Growth Annual Income Payment     Remainder
    1   $5,000,000    $250,000   $512,500    $499,800   $5,262,700
    5   $6,316,539    $315,826   $647,445    $499,800   $6,780,012
   10   $9,456,952    $472,847   $969.337    $499,800 $10,399,337
Summary $5,000,000   $3,408,963 $6,988,374  $4,998,000 $10,399,337
      Bullet Proofing a GRAT
John should consider funding an ILIT (for
the benefit of Lawrence) to provide the funds
needed to pay estate taxes should John die
before the end of the GRAT term.
                           Installment Sale to a
        John
                              Grantor Trust                        Grantor /
                                                                 Dynasty Trust

                             John gifts 10% of S Corp stock
• John retains control        (10% x $5,000,000 = $500,000      • $500,000 FMV
  as 10% voting              less 40% discount = $300,000)
  shareholder
• John receives               John sells 80% of S Corp stock
  $170,000 annually                                             • $4,000,000 FMV
  (from interest              (80% x $5,000,000 = $4,000,000
  payment and $50,000
                             less 40% discount = $2,400,000)
  of dividends on the
                                                                • Trust earns 10% on
  10% voting shares)          Trust pays interest only for 20
                                years of $120,000 annually        $4,500,000 =
• John pays income                                                $450,000/ year
  taxes of $210,000                 ($2,400,000 x 5%)
  ($500,000 x 42%) - for                                        • Trust can use the
  annual “short fall” of                                          excess cash flow of
  $40,000 ($210,000 –               Trust’s Cash Flow             $320,000/year to
  $170,000)                              $450,000                 purchase life
• Paying IDIT’s income                  ($120,000)                insurance on
  taxes is equivalent of                 $330,000                 John’s life or John
  tax-free gift                                                   and Mary’s joint life.
             Charitable Stock Bail Out

                                    1. John transfers his voting shares to Lawrence
           John                        and his non-voting shares to the CRT, leaving
                                       Lawrence the sole shareholder. This
                                       terminates Subchapter S election.
2. John receives a charitable
   income tax deduction and
   income for the rest of his and       Charitable
   Mary’s lives.                        Remainder
                                         Unitrust

                  3. Stock is transferred
                     from the trust to the S
                     corp in exchange for                                  S Corp
                     cash.

                  4. Life insurance can be purchased to “replace”
                     the wealth passing to the CRT.
“Wait and See” Buy-Sell Agreement
          During Lifetime
                                          Insurance
                                           Company

                      Business

      Pays                                    Pays
    Premiums         Agreement              Premiums


    John                                   Lawrence

        Each Shareholder Obtains Life Insurance On
                       The Other
“Wait and See” Buy-Sell Agreement
        Upon John’s Death
                                                 Insurance
                                                  Company
                                               Pays Death Benefits


                         S Corp

                     Option to Must
                     Purchase Purchase

     John                                          Lawrence
                       1st      3rd

      Stock Passes                                 Option to
                                         2nd       Purchase
                        John’s
                      Living Trust
  Why Use Life Insurance to Fund
      Buy-Sell Agreement?
Ø Creates a lump sum of cash when
  needed.
Ø Results in a quick settlement of the buy-
  sell transaction.
Ø Generally, an income tax free death
  benefit.
Ø Income tax free access to cash values for
  a lifetime buy-out.
             Key Employees
Ø Company can purchase life insurance on the
  lives of its key employees to guard against
  financial loss.
Ø Company can provide key employees with an
  executive bonus.
Ø Company can implement a non-qualified
  deferred compensation plan to attract and retain
  key employees.
Ø Company can assist key employees in
  purchasing life insurance through a split-dollar
  plan.
              Executive Bonus
                                              Insurance
      Company
                                               Company
                                     2
                  1
                                              3

                        Key Employee


1 Tax-deductible bonus from employer to key
  employee.
2 Bonus dollars fund a life insurance policy owned by the key
  employee. Key employee is taxed on the bonus as ordinary
  income.
3 Key employee uses the financial asset values to supplement
  retirement income or provide survivor benefits.
            Non-Qualified Deferred
             Compensation Plan
                     2
                                                 Insurance
        Company
                                                  Company
                                             3
        1
                4
          Key
        Employee

1 Employer promises to provide future retirement
  benefit.
2 Employer may purchase life insurance to “informally” fund
  benefits.
3 Asset values help pay benefits and/or recover costs.

4 Benefits are paid based on contractual specifications.
                     Split Dollar Plan
                          1
                                                             Key
           Company
                                                           Employee
                                                      3

                                    2

                                 Insurance
                                 Company

1   A face amount and premium for a life insurance policy is determined and the
    employer lends this premium to the employee.
2   The loaned premium is used to pay for the life insurance policy. The
    employee owns the policy.
3   The employee executes a collateral assignment on the policy to secure the
    employer’s loan. Annual interest on the loan is assessed at an appropriate
    interest rate, often the Blended Annual Rate or Long-Term Applicable
    Federal Rate, as published by the Internal Revenue Service. The interest is
    usually treated as bonused income to the employee.
                      Split Dollar Plan
                           1
                                                              Key
            Company
                                                            Employee
                                                        3
                  4
                                      2

                                   Insurance       5
                                   Company



4   The portion of the cash value or death benefit assigned to the employer to
    repay the loan is paid off at retirement or death, from the cash values, if
    available. Death benefit may be forgiven by the employer.

5   After paying off the loan to the employer and terminating the assignment, the
    employee may access policy values to supplement his/her retirement income or
    pass tax free death benefits to his/her descendants.
         Estate Equalization
John and Mary can leave Jennifer their non-
business assets.

John and Mary can “make up” the difference
by funding a survivorship ILIT for the benefit
of Jennifer.
                    Estate Equalization
  John & Mary 1. John & Mary create an irrevocable trust, and make
                 gifts of life insurance premiums to the trust.



                2. Pays Insurance Premium.
   Insurance                                                     ILIT fbo
   Company                                                       Jennifer
                3. Pays death benefit upon death of John &
                   Mary – income and estate tax free!


John & Mary’s
   Estate


    6. Pays Debts
       and Taxes.
                        IRS
                   Family Bank
Structure:
  A family LLC or family limited partnership.

Members/Partners:
  Lawrence and Jennifer.

Capital Contributions:
  Either gifts from John and Mary and/or contributions
  directly from Lawrence and Jennifer.

FLLC’s/FLP’s Investments:
  A survivorship policy on John and Mary’s lives.
                  Family Bank
Indicated Use:
  When shares in the Company are transferred (either
  during John’s lifetime or death) to both children.

Purpose:
  To provide funds for Lawrence to “call” Jennifer’s shares,
  or for Jennifer to “put” her shares to Lawrence.
“When I go, I plan on taking at least two of
    my estate-tax lawyers with me.”
 The End.
Thank You!
   The Role of Life Insurance
in Business Succession Planning




   Julius H. Giarmarco, Esq.

				
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