8997 / What potential tax consequences arise if the corporation owns the life insurance policy on a majority shareholder’s life used to fund a buy-sell agreement, but the named beneficiary is a party other than the corporation?

Potential adverse estate tax consequences may result if a life insurance policy used to fund a buy-sell agreement is actually owned by the corporation itself, but the policy beneficiary is someone other than the corporation. If, at the time of death, the insured owns more than 50 percent of the corporation’s voting stock, the entire value of the death benefit paid out under the policy may be included in the insured’s estate.¹ This is because, as a majority shareholder in the corporation that owns the actual policy, the insured will be deemed to have retained incidents of ownership in the policy that are sufficient to warrant inclusion of the death benefit in his or her estate.

These adverse tax consequences only exist if three circumstances are present: (1) the corporation is the named owner of the policy, (2) the insured owns more than a 50 percent interest at death and (3) the policy beneficiary is not the corporation.

Any proceeds payable to a third party for a valid business purpose (for example, satisfaction of the corporation’s business debt), so that the corporation’s net worth is increased by the amount of the proceeds, will be deemed to be payable to the corporation and so will not be attributed to the decedent.