Ch 5: Life Insurance- Advanced Concepts

Mackey learned that he had contracted a rare disease and is not expected to live more than five years, but is still able to perform all activities of daily living. He has a life insurance policy with a face value of $400,000 that he could sell to a viatical company for $200,000. On the policy, Mackey had paid premiums of $2,000 each year for 15 years, and the cash value is $26,000. What capital gain will Mackey have to report if he sells the policy to the viatical company?

$170,000

A viatical settlement company purchased a $250,000 policy for $160,000. It paid additional premiums of $7,000 (in total) over the next three years before the insured died. What income must the viatical company report from the policy proceeds in the year of the insured's death?

$83,000 ordinary income (250-160)-7

The Arthur Reynolds Company (ARCO) is a medium-sized machine tool company. The Company has three key executives whose retention by the Company is important to the Company's future growth and expansion of operations. The board of directors is considering several special employee benefit plans that could be implemented to make continued service with ARCO attractive for the three executives. Which of the following statements concerning benefit plans being considered by the ARCO board of directors is (are) correct? 1. Three $100,000 ordinary life insurance policies would provide capital accumulation and estate liquidity for each of the three families. 2. The attitude of ARCO's board of directors toward portability of any benefit plan established would likely parallel that of the three executives. 3. Evidence of insurability is usually required for small group carve-out plans.

1 and 3

Assume ARCO's board elects to offer their three executives a split-dollar plan with a $100,000 policy owned by ARCO on each of the three executives. Under these assumptions, which of the following statements is (are) true? 1. The executive will be taxed on the Table 2001 cost as additional compensation if the executive pays no portion of the annual premium. 2. The employer must pay all of the premiums under a split-dollar plan. 3. The executive will have to pay interest (or be taxed on this amount) on the outstanding loan balance associated with any premiums paid by the employer. 4. The executive will be taxed on all premiums paid by the employer in the year paid.

1 only

Betty owns a $150,000 whole life participating insurance policy that she purchased ten years ago. She has paid premiums of $4,000 each year since she bought the policy, and the current cash surrender value is $60,000. Betty has received $10,000 in paid dividends since the policy inception. Which of the following statement(s) is/are correct regarding Betty's policy? 1. If Betty surrenders the policy now, she will have a taxable gain of $30,000 taxed as ordinary income. 2. The dividends that were paid on Betty's policy were subject to ordinary income tax treatment.

1 only Premium Payment $4k*10yrs= $40k Adjusted base 40k-$10k= 30k 60k-30k=$30k Taxable gain

Which of the following factors are desirable when an employee is seeking deferral of a portion of current compensation by means of an informally funded nonqualified deferred-compensation plan? 1. The employee's tax bracket will be lower after retirement. 2. The employee enjoys a strong personal current financial position. 3. The employer is in a strong financial position. 4. Assets used to fund the plan are irrevocably committed to the employee.

1, 2, and 3

Which of the following is true regarding employer contributions to secular trusts for employee-participants of a nonqualified deferred compensation agreement? 1. Participants have security against an employer's unwillingness to pay at termination. 2. Participants have security against an employer's bankruptcy. 3. Secular trusts provide tax deferral for employees until distribution. 4. Secular trusts provide employers with a current income tax deduction.

1, 2, and 4

Watson, Inc. has four equal partners. All four partners are interested in entering into a buy-sell arrangement. How many life insurance policies would be purchased to properly fund using a crosspurchase agreement?

12 policies.

Rick has an 18% nonqualified deferred compensation plan that is funded annually by his employer. Payments are made to a separate trustee of a secular trust who was selected by Rick and his employer. The employer contributions are discontinued at Rick's death, disability, or employment termination. When Rick retires or terminates employment, he will receive the proceeds from the trust. Which of the following is/are correct regarding the deferred compensation plan? 1. The contributions are not currently taxable to Rick because they are subject to a substantial risk of forfeiture. 2. The contributions to the plan are currently subject to payroll taxes. 3. The employer can deduct the contributions to the plan at the time of the contribution.

2 and 3

Which of the following statements concerning a Section 162 bonus plan are correct? 1. The plan must provide benefits on a non-discriminatory basis. 2. The life insurance premiums are deductible by the employer. 3. The employee must pay income tax on the premiums. 4. The life policy is owned by the employer or a trust set up by the employer.

2 and 3

Which of the following is false regarding a deferred compensation plan that is funded utilizing a rabbi trust? 1. Participants have security against the employer's unwillingness to pay. 2. Rabbi trust provide the participant with security against employer bankruptcy. 3. Rabbi trusts provide tax deferral for participants. 4. Rabbi trusts provide the employer with a current tax deduction.

2 and 4

Elijah, who is seriously ill, is thinking about entering into a viatical agreement. Which of the following statements concerning a viatical agreement is (are) correct? 1. It is usually created only if the insured has less than 60 days to live. 2. It usually pays the insured something less than the life insurance policy's face amount.

2 only

Which of the following statement(s) is/are correct regarding buy-sell arrangements? 1. Entity purchase arrangements increase the income tax basis for some survivors upon the death of another owner. 2. Cross-purchase arrangements increase the income tax basis for all survivors upon the death of another owner.

2 only

If a formally funded nonqualified deferred-compensation plan is used, the employee may still avoid receipt of taxable income if:

A substantial risk of forfeiture is associated with the arrangement.

Which of the following situations indicate(s) the need for life insurance for a closely held business or its owners? 1. The potential death of a valuable key employee. 2. The potential death of an owner whose widow(er) would not be a compatible partner for the surviving owner. 3. The potential death of a minority owner with substantial estate debts, but with no cash.

All the above

In 2020, Chip, an accomplished professional race car driver, is to receive a signing bonus for agreeing to drive for Hot-Lap International, a racing team. Hot-Lap agrees to establish a NQDC agreement with Chip to defer the bonus beyond Chip's peak income producing years. Hot-Lap transfers the bonuses to an escrow agent, subject to the risk of forfeiture to team creditors in bankruptcy, who invests the funds in securities acting as a hedge against inflation. The bonus is deferred until 2021 and is then paid to Chip in years 2021-2027. When is the income deductible by the employer and includible by Chip?

Employer Deduction: 2021 - 2027 Employee Deduction: 2021 - 2027

In a properly drawn business buy-sell agreement funded by life insurance for a six-person partnership: 1. The cross-purchase approach will be found to be more efficient than the entity approach. 2. The surviving partners are given the option to buy the interest of a deceased partner.

Neither

All of the following are reasons that an employer might favor a nonqualified plan over a qualified retirement plan except:

Nonqualified plans typically allow the employer an immediate income tax deduction.

Cindy Sue has been with CS Designs, Inc. for five years. CS Designs has a deferred compensation plan to provide benefits to key executives only. CS Designs contributed $400,000 into a trust for Cindy Sue's benefit under the company's deferred compensation plan. The plan requires that executives must work for the company for 10 years before any benefits can be obtained from the plan. Cindy Sue has come to you to determine when she will be subject to income tax on the contribution by the employer. Which of the following is correct?

Since Cindy Sue cannot receive the benefits until she has been with the employer for 10 years, the substantial risk of forfeiture doctrine will not require inclusion in income for the current year contributions made by the employer.