Tax deductible buy-sell: Is it possible?

By Nick Paleveda MBA J.D. LL.M

National Pension Partners


Life insurance is generally not income tax deductible. However, many corporations have a need for life insurance in a buy-sell agreement. Can you create a structure where the life insurance is income tax deductible?

One answer may be a qualified plan. However, there are challenges to purchasing life insurance inside of a qualified plan to suit a buy-sell arrangement.

1.The life insurance is subject to the "incidental benefit rule" under Rev. Rul 74-307. This means that up to 50 percent of the annual contribution in a whole life policy and up to 25 percent in a universal life policy may go into the plan. The other 50 percent must be invested in a side account or annuity.

2. The plan must consider all of the employee benefits and incorporate 40 percent of the eligible employees into the plan. This can be a problem if the company becomes too large. The life insurance benefit will now be on employees A, B and C who are not part of the buy-sell arrangement.

3. The benefit of the plan must be exclusively for the the employees, and the death benefits must be used to fund the qualified pre-retirement survivor annuity for the surviving spouse, absent a qualified ERISA waiver. The problem in this case may be solved by a qualified ERISA waiver issued by the spouse.

Conclusion

In rare circumstances, you may be able to set up a buy-sell arrangement funded with tax deductible dollars. The large company makes this an almost impossible dream. In other cases, the planner may be able to take into account the death benefits from the qualified plan when setting up the buy-sell arrangement. In any case, a deductible buy-sell arrangment may not be impossible, but may be difficult to achieve.