Will sale of a deceased’s stock under a cross-purchase insurance-funded buy-sell agreement result in income tax liability to the deceased’s estate?
Normally, no taxable gain will result to a deceased’s estate if stock is sold to surviving individual shareholders at its full market value under a standard buy-sell agreement. At the stockholder’s death, the stockholder’s stock receives a new tax basis equal to its fair market value at the time of death. Because the sale price under a properly designed buy-sell agreement usually is accepted as the fair market value of the stock, the basis and sale price normally will be the same. Consequently, there should be no capital gain. Since individuals, rather than the corporation, purchase the stock, the payment cannot be regarded as a dividend However, if the parties to the buy-sell agreement are related, additional caution should be taken to determine that the sale price under the buy-sell agreement is reasonable.
What are the income tax consequences of funding a stock purchase agreement with life insurance?
Premiums: Regardless of whether a stockholder pays premiums on a policy on the life of another stockholder or on a policy on the stockholder’s own life to fund an agreement, the stockholder cannot deduct premium payments.
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If stockholders attempt to use company-paid group term life insurance to fund their buy-sell agreement, the company may be denied a deduction for its premium payments. The IRS has held that premium payments under these circumstances are not related to a corporation’s trade or business. Premiums paid by an insured’s associate stockholders are not taxable income to the insured. If a corporation pays premiums on insurance to fund a buy-sell agreement between individual stockholders, premium payments will be taxable dividends to those stockholders.
(Related on ThinkAdvisor: 23 Days of Tax Planning Advice: 2017)
Death Proceeds: When each survivor applies the tax-free proceeds received to purchase stock from a deceased’s estate, .death proceeds are received free of income tax by surviving stockholders
Cost Basis: The amount a survivor pays an estate for stock becomes the survivor’s cost basis in the stock. This cost basis will be used to calculate the survivor’s gain or loss should the survivor dispose of the stock during the survivor’s lifetime. If a survivor holds stock until death, the estate will receive a stepped-up basis in the stock.
A cross-purchase agreement commonly gives each survivor a right to purchase from the deceased’s estate the un-matured policy on the survivor’s own life. If an agreement calls for transfer of a policy without cost to an insured, it would seem that the insured’s cost basis for the stock should be reduced by the value of the policy.