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Buy Sell Agreement Life Insurance Tax Implications

When setting up a buy-sell agreement between business partners, it`s important to consider the tax implications of funding the agreement with life insurance. Here`s what you need to know.

A buy-sell agreement is a legally binding contract between business partners that outlines what will happen if one partner leaves the business or dies. Funding the agreement with life insurance ensures that the surviving partner(s) will have the funds to buy out the deceased partner`s share of the business.

But how does life insurance funding impact taxes? Here are a few key things to consider:

Premiums: The premiums paid for life insurance policies used to fund a buy-sell agreement are not tax-deductible.

Proceeds: Generally, the proceeds from a life insurance policy are income-tax-free to the beneficiary. However, if the policy is owned by the business, the proceeds may be subject to estate tax if the business is large enough to trigger estate tax liability.

Transfer-for-value rule: If the life insurance policy used to fund the buy-sell agreement is transferred to a new owner, such as one of the surviving partners, the death benefit will be subject to income tax if the new owner paid less than the policy`s fair market value for it. This is known as the transfer-for-value rule.

To avoid triggering the transfer-for-value rule, it`s important to structure the buy-sell agreement and life insurance policy correctly from the beginning. For example, the policy should be owned by the individual partners, not the business, and the agreement should outline the terms of the transfer in the event of a partner`s death or departure from the business.

Overall, funding a buy-sell agreement with life insurance can provide important protection for business partners and their families. However, it`s crucial to consult with a tax professional and experienced insurance agent to ensure that the arrangement is structured properly and minimizes tax liability.

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