MetLife Sales Solutions: The Business Owned Life Insurance Alternative

The irrevocable life insurance trust (ILIT) has long been a traditional estate planning tool. It can be an effective way to own life insurance that provides liquidity at death while keeping the death benefit out of the estate of the decedent. ILITs can also be used to leverage the lifetime gift and generation-skipping transfer tax exemptions. While ILITs can be a very efficient method of owning life insurance, there are various considerations specific to ILITs of which one should be aware. In certain situations, there are alternative options to the ILIT clients should discuss with their legal and tax counsel, including using business entities as the owner of life insurance.


ILITs Generally

In order to exclude the life insurance proceeds from the estate, the insured cannot have any incidents of ownership in the policy. Therefore, the ILIT is drafted as an irrevocable trust and the insured/grantor has virtually no control over the policy owned in the trust. The ILIT can be drafted to provide some flexibility, such as providing a spouse or domestic partner access to trust principal and income, or by allowing the trust to make arm’s length collateralized loans to the grantor. But, generally, the grantor is giving up direct access to the policy in exchange for estate exclusion.


“Crummey” notices must be used in order to qualify any transfers or gifts to the ILIT for the gift tax annual exclusion. Since a gift to an irrevocable trust that does not immediately provide benefits to the beneficiaries is not considered a gift of a present interest, those gifts do not qualify for the gift tax annual exclusion. Consequently, the beneficiaries must be given, via written notification, a right to withdraw the gifts for a short window of time. This can pose problems with the funding of the policy if the beneficiaries actually exercise their rights to withdraw the gifts. In situations where there are concerns about spend thrift beneficiaries, annual exclusion gifts may not be desired and the gift exemption will be applied or gift taxes paid instead. In addition, there are some concerns about the IRS position on Crummey gifts.  Specifically, the IRS may challenge whether these gifts qualify for the annual exclusion if there is an implied agreement that the withdrawal rights will not be exercised.


Finally, in most situations, purchasing life insurance in an ILIT requires cash gifts. Using a client’s gift exemption and annual exclusions for cash gifts may not be as beneficial as gifting other types of assets, like business interests where estate freeze techniques and valuation discounts can make the gifts more effective.1 While all of the issues outlined above certainly do not offset the benefits of an ILIT, there may be alternatives to the ILIT that might be more effective in certain situations.


Entity Owned Life Insurance

For clients who have ownership interests in operating business entities, those entities may provide a possible alternative to the ILIT. The entity would be the applicant, owner and beneficiary of the policy. Upon the death of the insured, the proceeds are paid to the business entity and can then be used to purchase the client’s business interest, make distributions to the owners or fund other objectives such as key person replacement, stay bonuses or executive benefits to heirs in the business. By using the death proceeds to fund a redemption of the client’s business interest, estate liquidity can be provided in a manner similar to that of an ILIT.


Benefits of Entity Owned Life Insurance

Business entities such as C corporations, S Corporations, limited and general partnerships and LLCs can all be purchasers of life insurance instead of an irrevocable trust. Using a business entity to purchase life insurance can provide the following possible benefits over an ILIT:

  • Having a business entity purchase the insurance may provide more flexibility and control for the client than using an ILIT.
  • Having the entity purchase the insurance may eliminate the need for Crummey notices.
  • Gifting ownership interests in the business entity to the trust instead of cash for life insurance premiums may leverage the gifts by removing appreciation of the entity from the estate as well as offer possible valuation discounts for lack of marketability and/or control. With the increase and reunification of the gift, estate and generation skipping exemptions under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (TRA), substantial amounts of business interests can be gifted without paying a gift tax during 2011 and 2012.
  • Interests in the business entity can be transferred to the trust with minimized gift tax consequences using techniques like grantor retained annuity trusts, self-cancelling installment notes or installment sales to a grantor trust.
  • Frequently, the business entity is the source of cash flow from which gifts to an ILIT would have been made. By purchasing the insurance in the entity, the need for potentially taxable distributions from the entity (and the subsequent gift to the ILIT) can be minimized.

Considerations of Enitity Owned Life Insurance

  • Creditors of the business may make claims against the policy values.
  • Premiums are not deductible by the company and may be more costly for the company if it is in a higher tax bracket than the owner’s.
  • Should the company ever wish to distribute the policy, there may be tax implications.
  • For larger C corporations, life insurance cash values and death proceeds may result in the corporation being taxed under the corporate Alternative Minimum Tax (AMT).2
  • An ILIT can be structured as a dynasty trust and thus provide for the grantor’s family for generations and the ILIT may also provide creditor protection with respect to the beneficiaries. Business owned life insurance does not address these issues and the business interest would need to be transferred to a dynasty trust to provide the same benefits.

Income Tax Treatment of Entity Owned Insurance

Like personally owned or ILIT owned insurance, the payment of premiums by the business entity is not income tax deductible. Consequently, the business will be using after tax dollars to purchase the policy. In most situations, the payment of the death benefit will be income tax free to the business entity. However, there are a few situations where the death benefit could be taxable to the business:

  1. Under IRC 101(j), death benefits paid on employer owned insurance are automatically taxable to the extent that the proceeds exceed the cost basis of the policy. Fortunately there are exceptions to this rule as long as the insured is notified and consents to the purchase, and the insured falls into certain exempt classes.
  2. In a C corporation, the alternative minimum tax may cause some income taxation of the policy proceeds.
  3. If the policy is purchased from another party (such as the insured or another shareholder) and does not meet one of the exceptions to the transfer for value rule, the death benefit could be taxable. If a policy is purchased for consideration, and the purchaser is not one of the excepted parties, then the death benefit would be income taxable to the extent the proceeds exceed the company’s cost basis in the policy. The main exceptions that would apply to an entity purchase are transfers to a corporation where the insured is an officer (or shareholder) or to a partnership where the insured is a partner.

Estate Tax Treatment of Entity Owned Insurance

Generally, the death benefit paid on a policy owned by and payable to the business entity will increase the underlying value of the business entity and therefore the value of the grantor’s business interest, which is includable for estate tax purposes. However, the value of the policy will not be treated as included in the decedent’s estate under IRC §2042.


For example, if a company buys a $1,000,000 policy on a 10% shareholder and the shareholder dies, the value of the company is increased by $1,000,000. Since the deceased shareholder owns 10% of the company, the value of his or her shares is increased by $100,000 (10% of $1,000,000). This result can be very effective if the insured owns only a small interest in the business. On the other hand, if the grantor still owns most of the entity, then having the business purchase the insurance will result in that corresponding percentage of the death benefit increasing the business value included in the estate.


Using Split Dollar to Minimize Estate Inclusion

Because the value of the business still owned by the grantor (and consequently that percentage of the life insurance death proceeds) will be included in the estate, having an entity purchase the insurance is most effective when the majority of the business has been gifted or sold prior to the purchase of the insurance. In situations where the grantor still owns most of the business, using a properly designed split dollar arrangement between the business and the irrevocable trust can minimize estate inclusion of the policy proceeds. If a corporation owns life insurance on its sole stockholder, or a controlling stockholder, the incidents of ownership in the policy are attributed to the stockholder to the extent that the proceeds of the policy are not payable to or for the benefit of the corporation.  Therefore, if the client still owns a controlling share of the business, then a “majority shareholder” split dollar design might be used where the company retains no incidents of ownership and has nothing more than a security interest in the policy owned by the irrevocable trust. The company must be prohibited from (1) borrowing against or making withdrawals against the policy, and (2) surrendering or cancelling the policy, or from taking any other action that would impair, defeat or otherwise adversely affect the rights of the trustee/owner. If the client does not have a controlling interest in the business, the split dollar agreement could be a standard economic benefit design between the business as policy owner and an irrevocable trust as recipient of a portion of the death benefit. The business would retain the right to the greater of premiums paid or cash value and would endorse the remaining death benefit to the trust.

With a split dollar plan, the grantor would need to report the annual economic benefit as taxable income and would also be treated as making a gift of economic benefit to the trust each year. By using split dollar, the death benefit above cash value can be removed from inclusion in the value of the business and can minimize estate inclusion while a gifting and/or sale program is being utilized to move the business to the trust.


Conclusion While having a business entity serve as an ILIT alternative may not always be appropriate; there are situations where this strategy should be evaluated. By purchasing the life insurance in a business entity where significant amounts of the business have already been gifted or by utilizing a gifting or estate freeze program of the business interest, significant wealth transfer leverage may be obtained. In addition, purchasing the insurance in the business may help solve cash flow and other problems associated with making cash gifts to pay premiums. Some of the benefits of an ILIT can still be achieved by purchasing the insurance in a business entity including providing a source of liquidity and leveraging wealth transfer. Business owner clients, with counsel from their legal and tax advisors, should consider the benefits of entity owned insurance instead of or, in addition to, the ILIT.




Use of discounts, though legitimate where appropriate, is often the subject of IRS scrutiny. Valuation should be determined by a qualified appraiser. It is important to confer with your independent tax and legal advisors regarding the use of this technique.


A “larger C Corporation” is defined as one with average annual gross receipts in excess of $5,000,000 for the first 3 years of business and $7,500,000 thereafter. This can result in up to 15% of the death benefit in excess of the corporation’s basis in the policy being paid as corporate alternative minimum tax. It is important to note that this added tax can be recouped in later years as a tax credit against the corporate regular tax.


IRC Reg § 20.2042-1(c)(6)


Pursuant to IRS Circular 230, MetLife is providing you with the following notification: The information contained in this document is not intended to (and cannot) be used by anyone to avoid IRS penalties. This document supports the promotion and marketing of insurance products. Clients should seek advice based on their particular circumstances from an independent tax advisor.


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