320 / If partners or stockholders enter into a buy-sell agreement and each purchases life insurance on each other’s lives to fund the agreement, are proceeds includable in an insured’s gross estate?

If, under a cross-purchase arrangement, proceeds are not payable to an insured’s estate, and an insured has no incidents of ownership in the policies on his or her life, death benefit proceeds are not includable in his or her gross estate.¹

The Tax Court has held that a provision in an agreement prohibiting a policy owner from surrendering the policy, borrowing against the policy, or changing the beneficiary of the policy without the insured’s consent did not give the insured incidents of ownership in the policy (but see Q 86).² The value of an insured’s partnership interest or corporate stock is includable.³ The value of any unmatured policies an insured owns on the life of his or her associates also will be includable.

Where proceeds are includable in the gross estate but the estate is obligated to apply them to the purchase price of the insured’s business interest, the value of the business interest will be includable in the gross estate only to the extent that it exceeds the value of the proceeds. In other words, there will be no double taxation.⁴

There is some legal authority to the effect that terms of a policy can be modified by terms of a business agreement. Thus, where an agreement gives all beneficial ownership in proceeds to an insured’s co-partners and obligates the parties to apply them to the purchase of the insured’s business interest, proceeds are not included in the insured’s gross estate despite a policy provision giving the insured the right to change the beneficiary.⁵