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Life Health > Life Insurance > Permanent Life Insurance

Clients With LLCs Need a Business Continuity Plan Check

By Jack Elder

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What You Need to Know

  • Business owners used to be able to use life insurance to fund buy-sell agreements.
  • For limited liability companies, the Connelly v. IRS ruling changed that.
  • One lesson is the importance of conducting regular buy-sell agreement reviews.

Your business owner clients understand the importance of preparing for the unexpected.

Whether it’s navigating a tough economic cycle, ensuring a smooth transition of ownership or protecting the business from financial strain, having a robust strategy in place is essential for the long-term health and success of a client’s business.

Well-drafted buy-sell agreements and the disability insurance often play an important role.

Another topic to consider is the role of insurance within a limited liability company, or LLC, structure, especially in light of the recent Supreme Court ruling in Connelly v. IRS.

The Connelly case has brought to light critical considerations for how insurance proceeds are treated for federal estate tax purposes.

The ruling underscores the need for business owners, particularly those operating within an LLC structure, to carefully evaluate their insurance planning strategies.

The implications of this decision are profound, especially when considering the unique dynamics of LLCs.

LLC Benefits

LLCs are a popular choice for business owners due to their flexibility and protection from personal liability.

However, this structure also presents some unique challenges when it comes to insurance planning, particularly in the context of buy-sell agreements and estate planning.

One of the key benefits of an LLC is the ability to tailor the operating agreement to the specific needs of the business and its members.

This includes the use of life insurance to fund buy-sell agreements, which can provide a seamless transition of ownership in the event of a member’s death.

The Connelly Ruling

However, as the Connelly case illustrates, the IRS’s treatment of life insurance proceeds can have significant tax implications.

The Supreme Court’s ruling in Connelly affirmed that life insurance proceeds, when used to fund a redemption obligation, do not reduce the value of the business for estate tax purposes.

For LLC owners, this means that the proceeds from a life insurance policy could increase the taxable value of the business, potentially leading to a higher estate tax liability.

To safeguard a client’s LLC from these unexpected tax consequences, work closely with a tax professional who can help the client use these best practices:

Review and update buy-sell agreements: Ensure that the client’s buy-sell agreements are up-to-date and reflect the current legal landscape, including the implications of the Connelly ruling. Business owners should be reviewing these agreements now in the light of Connelly and, in the future, every three to five years.

Consult with advisors: A business owner client should work closely with legal and tax advisors to understand how the IRS may treat life insurance proceeds within the client’s LLC structure. You, the tax advisors and the client should work together to develop strategies to mitigate potential estate tax liabilities.

Plan for liquidity: A business owner client should ensure that the LLC has enough liquidity to cover potential tax liabilities without disrupting business operations. This may involve setting aside additional funds or exploring options for deferring estate taxes.

The Connelly decision serves as a reminder of the complexities involved in insurance planning within an LLC.

Your business owner clients are responsible for ensuring their planning strategies not only protect their businesses but also minimize the risk of unintended tax consequences.

By taking a proactive approach and regularly reviewing insurance arrangements, those clients owners can safeguard their LLCs’ future and provide peace of mind for all stakeholders.

The U.S. Supreme Court building in Washington, D.C. Credit: Bloomberg

Jack ElderJack Elder is senior vice president of advanced markets at CBS Brokerage.

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