Can Shareholders of a C-Corp be Subject to Taxable Income if They are Beneficiaries of a Life Insurance Policy?

Demystifying Valuation, Economic Damages + Forensic Accounting

A C-Corporation should always be the owner and beneficiary of a life insurance policy to avoid taxable income to the surviving shareholders.

When contemplating the manner in which to fund a buy-sell agreement, life insurance is an extremely attractive option. A life insurance policy can provide liquidity when it is needed most upon the death of a business owner. Funds attributable to the death benefit of a policy can be used by the remaining shareholders to purchase the decedent’s equity interest.

Let’s assume that the three equal shareholders of Wannabe Inc., a C-corporation, enter into a buy-sell agreement which obligates the company to purchase three insurance policies insuring the life of each of the stockholders. Wannabe is the owner of the policies and the surviving shareholders are named as the beneficiaries of each policy.

Upon the death of shareholder 1, the death benefit is paid proportionally to the two remaining stockholders. The IRS deems the surviving stockholders’ insurance proceeds to be subject to ordinary income taxes.

In order to avoid income taxes, the corporation should be the owner and beneficiary of each policy.

By Gary Ringel, CGREA

Sources

“Business Succession Planning With C Corporations” published by Transamerica Insurance & Investment Group