Retirement Planning and Employee Benefits - Employer/Employee Insurance Arrangements

Which of the following statements best describes a golden parachute plan?

- A golden parachute plan is an arrangement between an employer and a valued employee that will provide the employee with severance benefits if the employer is sold and the new owner terminates the employee.

What is a split dollar rollout?

- A plan that was designed to take advantage of pre-1986 tax law that allowed individuals to deduct personal interest.

Which of the following are alternatives a shareholder may face if there is a death or permanent disability of a majority shareholder?

- Accept an adult heir of the deceased into management of the firm - Admit into active management of the firm outside interests to whom the stock of the deceased may have been sold - Purchase the stock from the disabled owner or from his or her estate

Which of the following describes a method of ownership of a life insurance policy subject to a split-dollar arrangement?

- Collateral assignment There are two methods of arranging policy ownership under a split-dollar plan. They are the endorsement method and the collateral assignment method.

What is a cross purchase buy and sell agreement?

- Each surviving owner binds himself or herself to buy the interest of the deceased owner.

If the employee is a controlling shareholder, where should the incident of ownership be attributed?

- Majority shareholder If the employee is a controlling shareholder, more than 50 percent in the employer corporation, the corporation's incidents of ownership in the policy will be attributed to the majority shareholder.

In general terms, the maximum amount of a key employee life insurance policy that may be subject to the corporate alternative minimum tax (AMT) is what percent?

15% In general, the maximum tax that can be imposed on death proceeds is 20% of 75% of the death proceeds, or 15%.

What is the total number of policies needed for a cross-purchase arrangement if there are seven employees?

42 The formula is n(n-1). 7(7-1) =42

To maximize plan benefits with policy cash value, a split-dollar plan must remain in effect for what time frame?

- A split-dollar plan must remain in effect for a reasonably long time, 10 to 20 years, in order for policy cash values to rise to a level sufficient to maximize plan benefits

Mr. Jerome Fernando is the vice president of sales in Astrix Corp. As one of the founders, he owns a significant number of shares in the company. The corporation has purchased key employee life insurance on five of its employees, including Fernando, on which it pays premiums and is the beneficiary. What are the tax consequences of key employee life insurance for Fernando and Astrix Corp?

- Corporate-paid premiums are not deductible for income tax purposes. - The death benefits are income tax free to the corporation except for the possibility of Alternative Minimum Tax with C corporations. - Accumulation of income to pay for life insurance premiums above the limit specified by the IRS might be subject to accumulated earnings tax. The premiums paid by Astrix Corp. are not deductible for federal income tax purposes while the death proceeds will be tax free when paid to the corporation, except for the potential application of the Alternative Minimum Tax. If the corporation has accumulated earnings beyond the limit specified by IRS, then the further accumulation of income to pay life insurance premiums for key employee insurance potentially exposes the corporation to the accumulated earnings tax. Though there is no income tax to be paid by Fernando or his estate, Fernando's estate may have to pay estate tax as a result of the death proceeds. This is because the value of corporate stock held by Fernando is included in his gross estate for federal estate tax purposes. The insurance proceeds increase the value of the corporation, and therefore can be included in the value of the stock held by Fernando.

Which of the following is the correct tax treatment of partnership buy-and-sell life insurance?

- Death proceeds are income tax free. - The cost basis of each surviving partner is affected by the proceeds received or the amount paid for the deceased partner's interest. The income tax treats partnership buy-and-sell life insurance the same way as it does personal insurance. Premiums are not income tax deductible whether paid by the partnership or a partner. Death proceeds are normally income tax free. The cost basis of each surviving partner is increased by the proceeds received by the partnership in the case of the entity plan and by the amount paid for the deceased partner's interest under the cross-purchase plan. Life insurance death proceeds are excluded from the gross estate of the insured unless the insured possesses any incidents of ownership or the proceeds are payable to or for the benefit of the insured's estate.

If there is a death or total and permanent disability of a majority shareholder in a closed corporation, the other shareholders face four alternatives. Which of the following is NOT one of those alternatives?

- Dissolve the corporation. The death or disability of a shareholder does not legally dissolve a corporation. The alternatives available to the shareholders are to accept an adult heir of the deceased into the management, pay dividends equal to the salary of the deceased or disabled shareholder, admit outside interests into the management, or purchase the stock from the disabled owner. These alternatives are usually undesirable or impracticable to the surviving shareholders and can be avoided by a properly drawn buy-and-sell agreement.

Shareholders interests in a buy and sell agreement are determined when a shareholder passes away. State True or False.

- False Each shareholder's interest is valued at the time the agreement is drafted, and it should be revalued periodically and the agreement amended to incorporate the new values.

Which of the following characterizes a highly compensated individual for the purposes of defining a parachute payment?

- Highest paid 1% of company employees, up to 250

What is a limited partnership?

- It consists of at least one general partner and one or more limited partners.

What is a reverse split dollar?

- It is a plan in which the employee has the right to policy cash values up to the aggregate of his premium payments.

What is a leveraged split dollar?

- It is a plan that is intended to lower the cost of a split-dollar plan for a key person by a borrowing that takes advantage of this exception.

What is equity split dollar?

- It is an arrangement in which the employer's interest in the policy cash value is limited at all times to the aggregate premiums it has paid.

What difficulties can be avoided upon the death of a partner if members of a partnership enter into a buy-and-sell agreement?

- It may result in a forced sale of assets at a fraction of their normal value - Goodwill is completely lost - Partners may lose their means of earning a living The law provides that upon the death of a general partner, the partnership is dissolved. Dissolution of the partnership is not taxed, but the deceased partner's interest in the partnership may have to be used in paying his or her estate tax. This may result in the forced sale of assets, usually at a fraction of their normal value, and goodwill is completely lost. It usually results in them losing their very means of earning a living.

What is not a potential advantage of a buy-and-sell agreement funded by insurance on a sole proprietor's life?

- It would allow the government to force liquidation of the business. A properly funded advance agreement whereby the sole proprietor agrees to sell and another party agrees to purchase the business interest on the proprietor's death or disability could preserve the firm's going concern value. Key employees who are perhaps dependent on the business for their livelihood might find the prospects of acquiring the business attractive. A buy-and-sell agreement funded by insurance on the proprietor's life could guarantee their eventual ownership of the business, not just employment. It would also act as an inducement for the key employees to remain with the business. Premiums for this insurance are not tax deductible, but policy proceeds received would be income tax free.

What are some of the problems for a business without a funded buy-sell agreement?

- No identified buyer(s) who must buy - No established funding Some of the problems for a business without a funded buy-sell agreement are: · No set value for business · No identified buyer(s) who must buy · No established funding · No requirement for family or heirs to sell to surviving owners or employees

Robin Stewart wishes to provide his employees with a split-dollar life insurance policy. For which age groups are the split-dollar plan more applicable?

- Split Dollar life insurance is appropriate for the age groups: 30s, 40s and 50s.

If the corporation is in a lower tax bracket than the shareholders, which type of plan would be preferred?

- Stock Redemption If the corporation is in a lower tax bracket than the shareholders, a redemption plan may be preferred. This is because premium payments would take a smaller share of the corporation's after-tax income than it would of the shareholder's after-tax income.

Select the statements that apply to an entity buy-and-sell agreement?

- The business is obligated to buy out the ownership interest of any deceased or disabled owner. - Each owner binds his estate to sell his business interest to the business if he is the first to die. Under an entity buy-and-sell agreement, the business itself is obligated to buy out the ownership interest of any deceased or disabled partner. Each partner binds his estate to sell his business interest to the business if he is the first to die. Therefore, this agreement is between the business enterprise and its owners. Under a cross-purchase buy-and-sell agreement, each owner binds his estate to sell his business interest to the surviving owners, and each surviving owner binds himself via the agreement to buy the interest of the deceased owner. This agreement is among the business owners themselves.

What is an entity buy and sell agreement?

- The business is obligated to buy out the ownership interest of any deceased or disabled partner.

Which of the following is true regarding the traditional income tax consequences of a split-dollar arrangement?

- The employee is taxed on the amount of economic benefit received. The traditional income tax consequences of a split-dollar plan are that the employee is considered to be in receipt each year of an amount of taxable economic benefit. The employer cannot deduct any portion of the premium contribution. Death benefits from a split-dollar plan, both the employer's share and the employee's beneficiary's share, are generally income tax free.

What is collateral assignement method?

- The employee or a third party is the owner of the policy and is responsible for premium payments.

What is endorsement method?

- The employer owns the policy and is primarily responsible to the insurance company for paying the entire premium.

In a sole proprietorship, who is obligated to liquidate the business upon the death of the proprietor?

- The proprietor's personal representative Upon the death of the proprietor, the proprietor's personal representative generally is obligated to liquidate the business. The personal representative is usually named in the last will and testament of the proprietor and could be the spouse or heirs of the proprietor. In a sole proprietorship, a partner does not exist.

What is CPS 58 offset plan?

- The purpose of this arrangement is to zero out the employee's income tax cost for the plan.

What are the rights of a minority shareholder's beneficiaries in a closely held corporation?

- They are entitled to a proportionate share of dividends - They have the right to examine corporate records with legitimate reason - They are entitled to participate in all shareholder activities Though the minority shareholder's beneficiaries cannot exercise control in the management of the corporation, they may be able to render life miserable for the survivors. They have rights such as being entitled to a proportionate share of dividends, to examine the corporate records with legitimate reason, and generally to participate in all shareholder activities. The majority shareholder's beneficiaries can enforce their wills on the surviving shareholders, whereas minority shareholder's beneficiaries generally cannot.

AAA corporation has a stock-redemption plan and is going to have to claim bankruptcy. Creditors can get access to the cash values in the stock-redemption plan. State True or False.

- True Any policy cash values and death proceeds are, therefore, subject to attachment by the creditors of the corporation because the policy values are general corporate assets.

Which of the following statements are NOT true regarding a split-dollar life insurance arrangement?

- Typically, a split-dollar arrangement involves an executive purchasing life insurance and naming the employer as beneficiary and owner of the contract. - Under the classic or standard split-dollar plan, the employer pays the entire premium equal to the increase in cash surrender value of the policy for the year, or the net premium due. A split dollar arrangement is between an employer and an employee and involves a sharing of the costs and benefits of the life insurance policy. Under the classic or standard split-dollar plan, the employer pays a portion of the premiums equal to the increase in cash surrender value of the policy for the year, or the net premium due. It is under the employer-pay-all arrangement that the employer pays the entire premium with the employee paying nothing

What is split of cash value?

- Used to reimburse the employer, in whole or part, its share of the premium outlay, in the event of the employee's death or termination of the plan

A buy-and-sell agreement by members of a partnership does which of the following?

- bind the surviving partners to purchase the partnership interest of the first partner to die or become disabled. - obligate the deceased partner and his or her estate to sell this interest to the other partners. A buy-and-sell agreement by members of a partnership binds the surviving partners to purchase the partnership interest of the first partner to die or become disabled and obligates the deceased partner and his or her estate to sell this interest to the other partners. It avoids a forced sale of the business to someone else or having to take an heir of the deceased partner who is not familiar with the business into the partnership.

The law provides that any change in the membership of a partnership causes its:

- dissolution A partnership is subject to the general rule of law that any change in the membership of the partnership causes its dissolution. If prior arrangements for continuation of the business have not been made, the death or disability of a partner could result in bankruptcy, insolvency or liquidation of assets.

The overhead disability plan pays a reimbursement-type benefit based on covered expenses. Which of the following do these expenses not include?

- rent or mortgage payments on private residence - installment payments for inventory Covered expenses usually are those that the IRS accepts as deductible business expenses for federal income tax purposes. They include rent or mortgage payments for the business premises, employee salaries, installment payments for equipment, which does not include inventory, utility and laundry costs, and business insurance premiums that are not waived during disability. Besides these, any other recurring expenses that the insured normally incurs in the process of running his or her business or professional practice are included in covered expenses. Personal expenses such as rent or mortgage payments on the person's private residence and medical expenses are not included.

The face value of life insurance on one of two partners that is used for funding a cross-purchase buy-and-sell agreement equals which of the following?

- the agreed-upon value of the interest that the surviving partner would purchase from the deceased partner's estate. Under the cross-purchase approach, the face amount of each policy usually equals the agreed-upon value of the interest that the surviving partner/policy owner would purchase from the deceased partner's estate. Under the entity approach, the face amount of each policy usually equals the value of the insured partner's ownership interest. A life insurance with the value of all surviving partners' interest or the entire business interest is not required for either agreement.

Disability buyout insurance policies are arranged so that benefits are payable after a certain period of disability. The duration is chosen to correspond to a trigger point, which is which of the following?

- the date designated in the formal buy-and-sell agreement at which the healthy persons must buy out the totally disabled insured/owner. Policies are arranged so that benefits are payable only after 12, 24, or 36 months of disability. The duration is chosen to correspond to a trigger point which is the date designated in the formal buy-and-sell agreement at which the healthy persons must buy out the totally disabled insured/owner.

If a severance benefit paid to a former employee and officer is considered to be an "excess parachute payment" under the tax law:

- the employer will not be able to take a deduction for the amount of the severance benefit payment An amount that is characterized as an "excess parachute payment" is subject to two tax sanctions: No employer deduction is allowed, and the person receiving the payment is subject to a penalty tax equal to 20% of the excess parachute payment.