Background

The Buy-Sell Insurance Entity (BSIE), also referred to as a special purpose buy-sell LLC, is an innovative legal and financial structure designed to address complex business succession, estate planning, and tax issues arising from traditional buy-sell agreements.

A BSIE offers a more streamlined and tax-efficient method for managing life insurance policies to fund buy-sell agreements among business owners.

The first LLC statute was established in Wyoming in 1977. This new business structure combined the limited liability features of a corporation with the tax efficiencies and operational flexibility of a partnership. Rev. Rul. 88-76 clarified that LLCs formed under Wyoming’s statute would be taxed as partnerships for federal tax purposes, provided none of the members are personally liable for the LLC’s debts.

Buy-Sell Agreements and Life Insurance

Traditional Methods

Cross-Purchase Agreements

• Desirable for the basic increase that surviving owners receive in their business interests.
• However, they become complex with multiple owners, requiring numerous life insurance policies.

Redemption Agreements

• Simplify insurance needs by having the entity own the policies.
• Can result in negative tax consequences and expose policies to business creditors.

Trusteed Cross-Purchase Agreements

• Addresses the complexity of cross-purchase agreements.
• Can trigger estate tax inclusion if not properly structured.

Challenges

Traditional methods often lead to administrative burdens and potential tax issues, such as loss of basis step-up for surviving owners and exposure to business creditors. The 2024 Connelly decision has frustrated redemption planning by creating uncertainty in valuing a redemption obligation.

Tax Considerations

Basis “Step Up”

Under IRC §1012, surviving owners receive an increase in basis in their business interests equal to the purchase price of the deceased owner’s interest. This may reduce potential capital gains tax upon a future business sale. Under IRC §1014, the decedent’s estate will receive a basis adjustment in the value of the shares.

Tax-Free Distributions

Life insurance proceeds distributed to members are income tax-free, ensuring tax efficiency. IRC §101(a) provides that life insurance death benefits are generally excluded from gross income.

Avoiding Transfer-for-Value Issues

The BSIE structure can avoid transfer-for-value problems arising from problematic redemption agreements or traditional trusteed cross-purchase agreements. IRC §101(a)(2) outlines the transfer-for-value rule and provides exceptions for transfers to the insured, a partner of the insured, a partnership in which the insured is a partner, or a corporation in which the insured is an officer or shareholder.

Estate Planning

Using a BSIE can help address estate tax issues by preventing business owners from having incidents of ownership in the policies, thus avoiding the inclusion of death benefits in their estates. This mitigates the concerns posed by IRC §2042, which includes life insurance proceeds in the gross estate if the decedent had incidents of ownership at the time of death.