COMMERCIAL INSURANCE

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.

COMMERCIAL

  • Please complete all form elements below to the best of your ability to aid us in providing the most accurate and competitive quote possible.
  • General Information

  • Current Coverage

  • BUSINESS INFORMATION:

 

Verification