April 11, 2024

Tax Talks

Life Insurance Redemptions Falling Under IRS Scrutiny

By: Dario Arezzo


Purchasing a life insurance policy is common in the farming business entity structure. Often times, farmers and businesses acquire insurance in order to fund payments to a deceased member’s estate without causing the business too much financial burden.

Let’s look at a common scenario where John and Bob own 50% each of the Family Farms, LLC that is worth $6 million. They decide to get life insurance on each other to facilitate a buyout of the other’s business interest for $3 million each. If the insurance was owned by both John and Bob respectively –  typically governed by what is known as a cross-purchase agreement – then if John died, Bob would receive the proceeds worth $3 million to pay John’s estate. At the end of the transaction, Bob would 100% own Family Farms, LLC, worth $6 million.

On the other hand, it is common for the actual business entities to own the policies.  In this example, that would mean Family Farms, LLC owns both $3 million policies on John and Bob. If John died in this scenario, the insurance money would come into Family Farms, LLC and then it would pay the money to John’s estate since it has a $3 million obligation.

Currently the Supreme Court, in Connelly v. U.S., is hearing arguments where the facts are quite similar. It is the IRS position that immediately at John’s death the business is worth $9 million dollars. That is, the original $6 million plus the $3 million coming in from the insurance proceeds. Curiously, the IRS maintains that the $3 million dollar obligation to John’s estate should not be considered a liability which would offset the $3 million dollar valuation increase, bringing the value back to $6 million.

Farm Credit East will stay up to date on how this case plays out, as it could affect many estate plans. Many individuals and businesses are in the process of evaluation their estate plans as we head towards the sunset of the higher estate exemptions. This may be one more area to review as those plans are reviewed.


Contact a Farm Credit East financial services specialist today to discuss your situation and options that may be available! 

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Tags: consulting, estate planning, taxes

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