Chartered Life Underwriter (CLU) Planning for Business Owners and Professionals Syllabus

How many life insurance policies does an entity redemption plan require for n owners?

Only n policies—the entity owns one policy on each owner's life and is the beneficiary.

In an entity redemption, does the corporation's purchase of stock give surviving shareholders a basis increase?

No. Because the entity buys the stock, surviving shareholders generally receive no increase in the cost basis of their own shares.

What corporate tax trap can arise when a C corporation uses life insurance to fund an entity redemption?

Life insurance proceeds received by a C corporation may increase its alternative minimum tax exposure (via the adjusted current earnings adjustment, historically) and the redemption can implicate accumulated earnings issues.

What is the 'family attribution' problem in entity redemptions of a family corporation?

Under IRC Section 318, a redeemed shareholder may be treated as still owning stock held by related family members, so the redemption may be taxed as a dividend rather than a sale/exchange unless Section 302/303 requirements are met.

What is a wait-and-see (hybrid) buy-sell agreement?

An agreement that does not commit upfront to cross-purchase or entity redemption; it gives the entity a first option to buy, then the surviving owners an option, with a backstop requiring the entity to buy any interest not purchased.

What is the principal advantage of a wait-and-see buy-sell agreement?

It provides flexibility to choose, at the time of the triggering event, the most tax-advantageous purchaser (entity or individuals) based on then-current tax law and circumstances.

In a typical wait-and-see arrangement, who usually owns the funding life insurance?

Often the individual owners own the policies (cross-purchase style ownership), preserving the ability to lend or contribute funds to the entity if the entity ends up making the purchase.

Why must a buy-sell agreement establish a valuation method?

To fix or determine the purchase price objectively, avoid disputes among owners and heirs, provide liquidity, and potentially set the value for federal estate tax purposes.

What are common methods for setting price in a buy-sell agreement?

A fixed/agreed price (periodically updated), a formula (e.g., book value or capitalized earnings), or an independent appraisal at the time of the triggering event.

Under IRC Section 2703, when will a buy-sell price be respected for estate tax valuation?

When the agreement (1) is a bona fide business arrangement, (2) is not a device to transfer to family for less than full consideration, and (3) has terms comparable to arm's-length arrangements among unrelated parties.

How are life insurance death proceeds generally treated for income tax when used to fund a buy-sell?

Death proceeds are generally received income-tax-free under IRC Section 101(a).

What is the 'transfer-for-value' rule and why does it matter in buy-sell funding?

If a life insurance policy is transferred for valuable consideration, the death proceeds become income-taxable (except for the cost). This is a risk when policies are reassigned, e.g., switching from cross-purchase to entity plans.

Name a transfer-for-value safe-harbor exception relevant to business buy-sells.

Transfers to the insured, to a partner of the insured, to a partnership in which the insured is a partner, or to a corporation in which the insured is a shareholder or officer; also transfers where basis carries over.

Why are cross-purchase policies often safer than entity policies under the transfer-for-value rule when ownership changes?

Transfers between partners (or to a partnership in which the insured is a partner) are exempt, whereas transfers to co-shareholders of a corporation are NOT a listed exception, creating a transfer-for-value risk.

What is a disability buy-out (DBO) agreement?

A buy-sell arrangement triggered by an owner's long-term total disability, requiring the buyout of the disabled owner's interest, commonly funded with disability buy-out insurance.

How does disability buy-out insurance typically pay benefits?

After a long elimination period (often 12-24 months) confirming permanent disability, benefits are paid as a lump sum, in installments, or a combination, to fund the purchase of the disabled owner's interest.

Are disability buy-out insurance benefits taxable to the business or recipient?

Benefits used to purchase the disabled owner's interest are generally received income-tax-free because premiums are paid with after-tax dollars and are not deductible.

What is key person (key employee) insurance?

Life and/or disability insurance owned by and payable to the business on the life of a key employee, to offset the financial loss caused by that person's death or disability.

Who owns, pays for, and benefits from key person life insurance?

The business owns the policy, pays the premiums (which are NOT tax-deductible), and is the beneficiary of the proceeds.

How are key person life insurance premiums and death proceeds taxed to the business?

Premiums are not deductible (IRC Section 264). Death proceeds are generally income-tax-free, provided the employer-owned life insurance notice and consent rules of IRC Section 101(j) are satisfied.

What are the IRC Section 101(j) requirements for employer-owned life insurance proceeds to remain tax-free?

Before issuance, the employer must notify the employee in writing, obtain written consent, inform them the employer will be beneficiary; and the insured must be a director/highly compensated employee or proceeds paid to heirs—plus Form 8925 reporting.

What is nonqualified deferred compensation (NQDC)?

An unfunded employer promise to pay a select group of management or highly compensated employees compensation in a future year, outside the limits and rules of qualified plans.

Why is NQDC generally restricted to a 'top hat' group?

To remain exempt from most ERISA participation, vesting, and funding requirements, the plan must cover only a select group of management or highly compensated employees.

When is the employer's deduction taken for nonqualified deferred compensation?

The employer deducts the payment in the year the employee includes it in income—generally when benefits are actually paid—matching the employee's taxation.

What does IRC Section 409A regulate, and what is the penalty for violation?

Section 409A governs the timing of deferral elections and distributions in NQDC plans. Violations cause immediate income inclusion of vested deferrals plus a 20% additional tax and interest penalties to the employee.

What is a 'rabbi trust' in NQDC planning?

An irrevocable trust holding informal funding for NQDC benefits; assets remain subject to the employer's creditors (protecting against the employer's refusal to pay but not against insolvency), so the benefit stays unfunded for tax purposes.

What is an executive bonus (Section 162) plan?

The employer pays a bonus (deductible to the employer, taxable to the executive) that the executive uses to pay premiums on a personally owned life insurance policy; the executive owns all policy values.

What is the chief advantage of a Section 162 executive bonus plan to the employer?

Simplicity and deductibility—the bonus is currently tax-deductible as reasonable compensation, with no ERISA plan administration and selective participation.

What is split-dollar life insurance?

An arrangement in which an employer and employee share the costs and benefits (premiums, cash value, and death proceeds) of a permanent life insurance policy according to a written agreement.

What are the two principal regimes for taxing split-dollar arrangements?

The economic benefit regime (employer owns the policy; employee taxed on the value of current life insurance protection/equity) and the loan regime (employee owns the policy; premium advances treated as loans subject to imputed interest).

When selecting an entity for tax efficiency, why might owners prefer an S corporation or LLC over a C corporation?

Pass-through entities avoid double taxation and allow business losses and income to flow to owners; the qualified business income (QBI) deduction may also apply, whereas a C corporation faces entity-level tax plus tax on dividends.