288 / Will a transfer of a life insurance policy by one stockholder to another, or by a stockholder's estate to a surviving stockholder, cause loss of the tax exemption for the proceeds?

Yes, unless the person to whom the policy is transferred is the insured ( Q 282) or unless the stockholders are also partners in a bona fide partnership ( Q 289).

The exceptions to the transfer for value rule do not include transfers between individual stockholders ( Q 286).¹ This is important to note in connection with an insurance funded buy-sell agreement on the cross-purchase plan where the plan involves more than two stockholders. After the first death, a survivor may wish to purchase a policy on the life of another survivor from the deceased’s estate. This purchase would disqualify the death proceeds for income tax exemption.

Moreover, suppose parties to a stock redemption plan wish to change to a cross-purchase plan and the corporation sells or distributes the policies to the insureds themselves. If the insureds then sell the policies to each other or exchange policies, the proceeds will lose their tax-exempt status. Even if no money is involved in the transaction, a valuable consideration can be found in the reciprocal transfers ( Q 280).

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Planning Point: To avoid transfer for value problems, some planners recommend that a policy owned by a shareholder on his or her own life be transferred to the corporation of which he or she is a shareholder. Then, subsequent to the transfer, the corporation enters into an endorsement split dollar agreement with an employee who desires to purchase the shares on the shareholder’s death.

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