G—Split Dollar Funding of Cross Purchase Agreement

Split-dollar insurance is not limited to merely funding the personal insurance needs of an employee. For example, the employee could choose to enter into a split-dollar agreement insuring
someone other than himself, such as a spouse or a child. Alternatively, the employee could choose to enter into a split-dollar agreement insuring another stockholder whose stock he is
obligated to purchase.

DURING LIFETIME. Assume that we have a corporation owned by two individuals, Employee A and Employee B. They enter into a cross-purchase agreement providing for the purchase and sale of their respective interests. This business funded strategy should not be confused with the cross endorsement buy-sell agreement.

The corporation purchases and owns a permanent life insurance policy insuring the life of each employee. In order to fund their mutual obligations to each other, A and B enter into splitdollar agreements with the corporation providing for the allocation of premiums, cash values and death benefits. In contrast to the typical employer/employee split-dollar plan that provides death benefits for the insured’s personal beneficiary, these agreements provide for A to receive the death proceeds from the policy insuring B, and for B to receive the death proceeds from the policy insuring A.

The corporation typically pays the entire premium for each policy (“employer pay all” plans) and owns all cash values. Each year income is imputed to the employee in an amount equal to
the “economic benefit” of the insurance protection received by the employee on the life of the other employee. Rather than having to come up with expensive after-tax dollars to pay
premiums, A and B pay taxes to the IRS on only this imputed income.

UPON DEATH. Assuming that A dies first, his stock interest would then pass to his family or estate. At the same time, the insurance company pays a portion of the death benefit to the
corporation to reimburse it under the terms of the split-dollar agreement. The remainder of the death benefit is paid income tax-free to B, which is then used by B to purchase A’s entire stock interest from A’s family or estate. As with a traditional cross-purchase buy-sell arrangement, this structure allows B to increase his or her basis by the amount to purchase A’s interest in the business.

Because of the 2017 Tax Act that reduced the top C corporation marginal tax rate to 21 percent, use of corporate dollars rather than individual dollars to fund a business buy-sell arrangement is especially appealing to many business owners. This arrangement provides the benefit of a traditional cross-purchase agreement (basis step-in and reduction in capital gains taxes) while allowing business owners to use corporate dollars for funding purposes.