Dear Michael: We have a family farm corporation which has evolved over the years. We wanted a simple way of moving our estate to our children and farming son and our CPA suggested this would be the best. At this point, we have just our farming business – machinery, grain, etc. – but none of our land in the corporation, as we rent the land back to the corporation to avoid Social Security taxes on this income.
Recently, we were told by an insurance agent that if we wanted our stock to go to our son in the business, the corporation could buy life insurance on us and redeem our stock upon our death. The agent thought it would be easier for the corporation to come up with the payment than our son. Can we use this as a deductible expense to the corporation as the agent did not know? Tax Season Always
Dear Tax Season: There are two basic types of business purchase plans used by most corporations, that being the corporate ‘buy-sell’ agreement and the corporate ‘stock redemption’ agreement.
Under the ‘stock redemption’ agreement, the stock would be ‘redeemed’ by the corporation buying the stock from your estates upon your death. Ostensibly, this money would then flow from your estate to the heirs you name in your will.
If the life insurance premiums have been deducted from your expenses in any way, the death benefits will then come to the corporation as taxable income to the C Corp or as pass-through taxable income in an S Corp. This would greatly complicate any redemption of your stock as corporate or personal income taxes would have to be completed prior to the redemption of your stock.
The other item that occurs when you ‘redeem’ stock is that the stock is simply retired in the corporation no matter if it is a C or S corp. The corporation has money due to the death benefit and your stock is retired.
Because there was no exchange from outside the business by an individual, no one can claim any tax deduction for having made an additional investment into the business.
Had your farming son owned and been the beneficiary of the life insurance under a ‘stock purchase plan,’ he would have been able to ‘invest’ this money into the corporation to purchase the machinery, grain and other assets. Any assets purchased would be deductible to him for depreciation, etc. unlike the internal stock redemption plan that merely retires stock.
With your son as owner, payer and beneficiary of the death benefit, he can now purchase your stock from your estate – you’ll have received a stepped up basis in the stock on some portions of your stock – and the money will then flow to the beneficiaries of your will. Your son will get a tremendous income tax benefit from handling the funds this way versus the stock redemption.
By the way, if your agent doesn’t know these things, find one who does – yours is playing out of his field of expertise. You need better advice.
This also prevents shares of the business from going to ‘unintended beneficiaries’ if your will does not address these shares. Many people forget when they convert their farm business to a corporation, they have to mention the ‘shares’ in their wills so as to be distributed by the instruction of these wills.
Too many people forget to change their wills and then the ‘shares’ become part of the ‘residue of your estate’ – commonly known as everything I didn’t mention by name in my will – which is typically split evenly between all the children.
Last, but not least, if your son can’t afford the premium, raise his wages or 1099 him for the income needed to pay this premium. Its better he pays a little tax now to reap the huge benefits of having him own the insurance outside the corporation.
Happy Easter everyone – our annual rebirth is finally here!
“Keeping the Family Farm in the Family”
Great Plains Diversified Services, Inc.
1424 W. Century Ave.
Suite 208, Bismarck, ND 58503-0917
Toll Free: 1-800-373-4078