Why Gifting Matters to You

Gifting is an important tool in designing many types of Advanced Markets cases.  Gifts can create opportunities but may also generate complications for producers and clients.

Questions you may be asking are, “How will knowing more about the gift rules help me in my career?” or “How will gifting help my client achieve their goals?”

Because your clients have the opportunity to realize significant financial and emotional value in making gifts, you will want to be knowledgeable about gifting.  The financial and emotional value clients experience through gifting can be enhanced with Life Insurance.

Generally, it’s not difficult to convince clients that they need insurance, but it’s hard to find the money to pay the premium.

Gifting may be the answer for getting the necessary premium dollars.

With Life Insurance, gifts serve a similar purpose.  A client may gift cash to an adult child so that child may purchase a policy on the parent/giver.  When the giver dies, the child receives a tax free death benefit that can pay for services or items that the giver may have previously supplied.

Consider This

For example, a father has three children, but only two of whom have interest in owning real estate that has been in the family for generations.

To equalize his estate, the father gives cash to the non-business heir, Jill, so she can buy a Life Insurance policy on him.  At the father’s death, the real estate can move to his two children that are interested in owning it, Jill receives cash from the policy’s death benefit while keeping the death benefit out of the father’s taxable estate.

Regardless of whether the gift is given for financial or emotional reasons, gifting can be a big part of a strategy to get clients closer to their desired goals.

For more information about gifting call your Life Sales & Marketing Representative.

A Buy-Sell: Cheap To Fund, But Expensive To Form?

Nothing saps the thrill of owning a sassy new automobile more than the increased premiums on the car insurance that are about half the amount of the monthly payment on your Little Deuce Coupe.

And those nifty printer/scanner/copier/faxing machines that they are practically giving away at Paper-clips ‘R’ Us don’t seem so nifty when you replace the ink cartridge(s) for the first time at a cost about equal to the original purchase price.

The phenomenon of deferred-sticker-shock can put the bite on what might otherwise be a nice insurance sale to fund a buy-sell agreement.

As an example:

Three young, non-smoking, healthy entrepreneurs, let’s call them Sharon, Caroline and Andrea, operate a promising LLC taxed as an S-Corp.  They agree to buy out the estate of any that might prematurely pass for $1,000,000.  They take out a policy on each for that amount to fund the buy-out.  On each policy the two non-insureds jointly own the policy on the insured, e.g. Sharon and Caroline own the policy on Andrea.

So Andrea dies and the $1,000,000 from her policy is used to buy her interest from her estate.  That’s all good as far as it goes.  But what happens to Andrea’s interest in the two remaining policies?  Well, because they were owned jointly, Sharon is now the sole owner of the policy on Caroline and vice versa.  The problem is that the shift in ownership caused by Andrea’s death is probably a transfer-for-value.  Up to one-half the death benefit could be subject to income tax if paid.

The most common exception to the TFV rule is an ownership change between partners.  The problem here is that the ladies’ company is taxed as an S-Corp and there may be reasons they don’t want to change to partnership taxation.  And the cost of creating a partnership simply to handle the insurance may be several times the annual premium on the insurance, all to avoid a tax hit that will only occur if a second death occurs while they are still operating the business.

Perhaps the best you can do is to suggest they discuss with their tax advisor the feasibility of an ownership reset if a first death occurs.  This would involve 1) transferring the remaining policies back to the insured (another TFV exception that also cleanses the policy of the taint of the TFV), 2) the creation of a partnership between the survivors (at least the cost is incurred only when needed), and 3) exchanging the policies to establish cross-ownership without any TFV issues.

The suggestion should be reduced to a writing that they can take to their tax advisor and that you can also keep in your file to document that you raised the issue.  We can help with that and also explain the problem to the client and their advisor.  Give us a call regarding this and any planning questions that come up, especially in your clients’ buy-sell planning.

Long ago in the pre-Tesla days of electric car design, a cartoon in the Saturday Evening Post (whatever that is) showed a salesman breaking down the cost of an electrical car to a prospective buyer:  “. . . and that will be $1500 for the automobile, and $35,000 for the extension cord.”

Insuring Key Signal-Callers

Why is it good to have a runner on second base?  Two reasons:  first, he’s in “scoring position” where a well-placed single will drive him home; and second, he can see the signals the catcher is giving the pitcher and pass them on to the batter.  In this subtle game of refined skills, anticipating the correct pitch turns even a mediocre hitter into Ty Cobb on the next throw to the plate.

The savvy fan is aware of the importance of the ongoing flurry of signals that continually circulate the field as players communicate information, strategies and intentions.  He or she is also aware that most originate somewhere in the dugout from one of several players or coaches, all making gestures to confuse and mislead the opponent as to their source.

And so it is, sometimes, with businesses whose success is often, in part, because of influence and input from people on the sidelines not involved in the day-to-day activity of the business.  Let’s call them key directors.

Consider This:

Sometimes a position on the Board of a company is an honorary thing, much like sitting in the celebrity box for the Macy’s Thanksgiving Day Parade.  More often it entails involvement in decisions and policies whose resolution and implementation require a level of street-smarts and industry background.

But, sometimes a director’s input is so impactful that the untimely loss of his or her services could have an adverse economic impact on the business.  A little company-owned coverage on such a director might seem wise and in order.

The problem is that carriers don’t traditionally recognize the importance of these off-field signal-callers for purposes of financially justifying any coverage applied for by the business.

But, as always, there is a crack in the door that affords an opportunity if a good case is made.

Even if convinced of a director’s unusually disproportionate importance, two things works against a carrier’s standard criteria for granting key person coverage:  1) the director is not an employee and  2) the director has little or no compensation on which to apply the “ten-times annual compensation formula”, employment status notwithstanding.

In a recent case we experienced success in getting a carrier to consider modest amounts of coverage ($250,000) on directors where their contributions to the economic well-being of the company was adequately demonstrated, and where they were paid a respectable modicum of compensation ($2,000 a year and $1,000 per meeting), and the company was taking steps to insure its traditionally-defined key people using the standard coverage guidelines.  The success on this small matter has allowed the agent to begin personal planning for two of the key people.

Back to baseball.  So potentially beneficial is the knowledge of a rival’s signals that teams have been known to put a mole in the centerfield bleachers with binoculars to monitor the opposing catcher’s instructions to the pitcher.  Recently the FBI has shown interest in investigating allegations of hacking the data bases of opposing teams for information.  Oh my!  What happened to the good old days when a strategy of success was as simple as Honus Wagner’s remark, “I just hit ‘um where they ain’t?”

Contact us with questions or for information on all your key person opportunities, especially those outside the common case parameters.

3 Ways Terrible Triads Ruin Tax-Free Death Benefits

You only need to look at your last paystub to be reminded that, as long as taxes are around, what you “get” is not usually what you “get”.  But the nice thing about the death benefit on a life insurance policy is that the amount you see on the contract is what you get . . . maybe.

The most powerful and the most sellable tax advantage of life insurance is the opportunity to offer a tax-free death benefit.  But it is only an opportunity and it can be lost if the policy is mishandled and structured improperly.

If too many cooks can spoil the broth, consider the affect that too many parties to a contract can have on taxation at death.

Every policy needs an insured, an owner and a beneficiary.  So long as the three spots are filled by just two parties you are probably in good shape – at least as far as the issue at hand.  But if the three roles are filled by three separate parties, tax implications come into play.

Such an arrangement is often referred to as the terrible triad, or the unholy trinity by those more theologically inclined.  Consider the possible unintended and unsavory circumstances that could result.

3 ways a terrible triad can effect your clients’ tax-free death benefit in their Life Insurance policy:

Family Planning Situation #1:  Assume that Dad is the insured, Mom is the owner, and Mom names Daughter as the beneficiary.  When Dad passes away Mom is deemed to have made a gift of the death benefit to Daughter.  If the death benefit exceeds $14,000 this year (which it probably will unless you bought the policy from a machine at an airport) then Mom has made a potentially taxable gift.  Potentially because Mom can use a portion of her lifetime exemption to avoid tax on the amount of the death benefit over $14,000.  This may not be a problem because Mom didn’t intend to use all of her $5,430,000 exemption amount anyway.  The inconvenience is that Mom must file a gift tax return in order to use part of her exemption to avoid the tax.

Family Planning Situation #2:  Dad has a $10,000,000 policy to benefit his four children that he doesn’t want included in his or his wife’s taxable estate.  He doesn’t want to go through the fuss of creating an irrevocable trust to hold the policy (call him penny-wise and pound-foolish) so he makes his most responsible child the owner trusting her to treat her siblings fairly.  She does, naming all four kids equal beneficiaries.  Dad dies and the IRS informs Daughter-owner that she has made three $2,500,000 gifts whose total is well in excess of her lifetime exemption.  Other than that Mrs. Lincoln . . .

Business Planning Situations:  A Company buys a policy on a non-owner executive to serve double duty as both key person insurance and to provide a death benefit to her spouse.   The executive dies and half the death benefit is paid to the surviving husband.  The IRS will treat the amount received by the husband as compensation to the executive, reportable on her final income tax return.  The good news for the company is it can take a business expense deduction for the amount allowing room for an additional bonus to help relieve the tax burden, if it is so inclined.

Fortunately the red flag in terrible triad scenarios is easy to spot: three different parties as the insured, owner and beneficiary.  If you are assisting in the structure of a policy and have questions, give us a call – we’re here to help!

LLC Family Values – No Longer Discounted?

The story of the prodigal son alerts us to the risks involved in completely turning assets over to our children without some restraints on their control of the property, lest they waste their substance on riotous living.

Taxpayers are often encouraged to do this by consolidating assets under the umbrella of a Family Limited Liability Company (Family LLC).  The entity is structured with two classes of ownership interest, one voting (usually 1-2% of the total interest) and the remainder non-voting, initially both classes owned by one or both of the parents.

The folks can then give away portions of the non-voting interest to the kids (protected from gift tax either through use of annual exclusions or the parents’ lifetime exemptions) allowing growth on the value of the transferred interests to occur outside their taxable estate all while maintaining complete say-so in how the company (i.e. its assets) is/are handled by virtue of their retention of all the voting rights.  This could also mean that they are reducing their allocation of any year-end earnings (especially if the LLC is taxed as an S-Corp), but this effect can be reduced through a salary paid to the parents for management of the company.

But the two-voting-class LLC can also allow for more effective use of the exclusions and exemptions.  A simple calculation suggests that giving 50% of a company with a $1,000,000 fair-market-value to your kids would constitute a $500,000 gift.  But, for now at least, a reasonable discount on the valuation of the transfer is allowed due to the transferred interest’s lack of marketability and voting rights.  So a successfully argued discount of 25% would result in a reportable gift of only $375,000.

But if those on the House of Ways and Means Committee proposing the Build Back Better Act have their way the discounting bonus available through use of Family LLC could be dramatically reduced.  The bill must make its way through the House Rules Committee and then the full House before even considered by the Senate, but in its current form it would disallow any such discount on the transfer of “non-business assets,” defined as passive assets held for the production of income and not used in the active conduct of a trade or business.  The most obvious example of non-business assets are marketable securities held in a Family LLC.

The announcement should serve as an urgent planning alert as the proposal, if left unaltered, would apply to transfers after the date of enactment of the BBB Act.

Call our team for assistance with any planning issues.