The Importance of
Insurance
Provided by Kiplinger
Many business owners' estates include as a primary
asset life insurance (or disability) policies that
name the company or the family members (or both) as
the beneficiaries.
Life insurance can play an important role in the
overall strategic-planning process. In the context
of a long-term gifting strategy, life insurance
proceeds can be used to "equalize" legacies among
active and non-active members of the next
generation. Let's say a small business worth $3
million will be gifted over time to a daughter who
has been very active in the business. This could be
offset by a life insurance policy in the same amount
on the founder, naming as the main or sole
beneficiary the son who practices dentistry
thousands of miles away. This "equalizes" the legacy
when the founder passes away. Most family-business
experts agree that this is not only a fair solution
but also is in the best long-term interests of the
business, rather than vesting one-half of the
ownership and control in a child who has not stepped
inside the company's doors since he was a teenager.
As good as it may sound at first, equalization is
not a panacea because valuation can be a moving
target. For example, do you adjust the amount of the
policy for the son with each new appraisal of the
business? If yes, why should the non-active son
continue to get a windfall for the efforts of the
daughter whose hard work has helped build the value
of the business? But in fairness to the son (given
the time value of money and assets), why should his
sister get a "gift" each year when he must wait
until his parents' deaths for his share? This is the
dilemma when life insurance is used as the
equalization tool instead of cash or a periodic
distribution of other assets in the estate.
In the context of a buy-sell agreement among
co-owners of a business (or among family members),
life insurance proceeds can be used to fund the
purchase of shares under the buyout clause in the
shareholders agreement, and therefore plays yet
another important role in the context of succession
planning. A buy-sell arrangement for co-owners to
purchase each other's business property is often
suggested for closely held businesses; upon the
death of an owner, the mechanism is in place for an
orderly transfer of ownership to the remaining
owners. Buy-sell arrangements typically include
details concerning who has the option to buy from a
seller (including an estate), how the sales price is
established and how the transfer may be financed. If
the buy-sell agreement is written for the death of
an owner, then life insurance becomes a financing
option.
Both life insurance and heir or third-party
financing can be used to transfer the business to a
continuing operator upon the property owner's death.
A child who operates a business owned by a parent
can purchase life insurance on the parent to finance
the property purchase from non-business heirs. Life
insurance proceeds can similarly fund a partnership
or corporate buy-sell arrangement.
Insurance premiums aren't tax-deductible, but the
proceeds are free from federal and state income tax.
Since the decedent never owned the policy, the
proceeds are not included in his estate. Life
insurance premiums begin when the policy is
purchased and cease at death (or sooner) when the
insurance proceeds are used to purchase the
business. In contrast, the cost of heir or
third-party financing will not begin until death and
will continue until payments are completed.
Andrew J. Sherman, a nationally recognized corporate
and transactional attorney, has spent over two
decades as a legal and strategic adviser to hundreds
of entrepreneurs and growing companies. He is a
senior partner of the Katten Muchin Zavis law firm
in Washington, D.C. and chairs its local corporate
and technology department. Sherman is also an
adjunct professor at the University of Maryland and
Georgetown University, where he teaches
entrepreneurship and business planning. |
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