CornerStone Financial

IMPORTANT DISCLOSURES

The information presented here is not specific to any individual's personal circumstances.

To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

Ownership of Life Insurance: Estate Planning

Ownership of Life Insurance: Estate Planning

What are the ownership issues of life insurance?

In estate planning, life insurance is purchased for several reasons: (1) to provide cash to the insured's family for daily living expenses, (2) to provide cash for potential death taxes and estate expenses, and (3) to provide a shelter from income taxes (for beneficiaries), potential estate taxes, or gift taxes (for insureds). In order to ensure that your beneficiaries receive the maximum benefit from life insurance policies on your life, you must structure ownership of these policies to minimize income and potential estate taxes.

To avoid taxes, you must also properly designate the beneficiaries.

Who should own your life insurance?

Not you (the insured), if your estate is more than the applicable exclusion amount

Life insurance proceeds from policies on your life may be includable in your estate for estate tax purposes if you own the policy outright, have any "incidents of ownership" in the policy at the time of your death, or transfer ownership of the policy within three years of your death. Inclusion of life insurance proceeds in your estate is not a problem if your estate (including any includable life insurance proceeds) is less than or equal to the applicable exclusion amount ($5,340,000 in 2014, $5,250,000 in 2013). If your taxable estate (excluding any includable life insurance proceeds) exceeds the applicable exclusion amount, you (the insured) should consider alternate ownership of policies on your life.

"Incidents of ownership" is a legal term that refers to the right of the insured to control the economic benefits of the policy. This definition encompasses more than outright ownership of the policy and includes the power: (1) to change the beneficiaries of the policy, (2) to pledge the policy for a loan, (3) to surrender or cancel the policy, (4) to assign the policy, or (5) to borrow against the surrender value of the policy. A reversionary interest in a life insurance policy is also treated as an incident of ownership in that policy and will result in inclusion of the value of the policy in the insured's estate if the value of the reversionary interest immediately before the insured's death exceeds 5 percent of the value of the policy. A reversionary interest in a life insurance policy includes the possibility that the policy or its proceeds may return to the decedent or his or her estate or may be subject to a power of disposition (e.g., a power of appointment) by the decedent.

Not your spouse if you live in a community property state, if your estate is more than the applicable exclusion amount

Community property states treat all types of community property, including life insurance, as being owned one-half by each spouse. Thus, one-half of a life insurance policy on your life that is owned by your spouse may be includable in your estate for estate tax purposes. As discussed above, this is not a problem if your estate (including any includable life insurance proceeds) is less than or equal to the applicable exclusion amount. However, if your estate (excluding any otherwise includable life insurance policies) exceeds the applicable exclusion amount, you should consider having ownership of the policy reside with someone other than your spouse.

Another individual

One person can own a policy insuring the life of another. Proceeds of such a policy will not be includable in the insured's estate, but the value of the policy may be includable in the owner's estate if the owner dies before the insured.

Premiums may be paid by the owner, but not from joint assets or community property belonging to the insured.

An irrevocable trust

An irrevocable life insurance trust (ILIT) is a type of trust that may be used to keep life insurance proceeds out of the insured's estate for estate tax purposes. The trustee of the ILIT is the owner of the policy, and the ILIT is the beneficiary. Upon the insured's death, the proceeds are distributed to the ILIT and distribution to the beneficiaries of the ILIT is made according to the terms of the trust agreement.

An ILIT is a complex estate planning tool and must be properly created to be effective. If you are interested in taking advantage of such a device, you should seek the assistance of an estate planning professional in your state.

What if you transfer an existing policy to another owner?

The proceeds may be taxable if you die within three years after the transfer

If you own a policy on your life, you may want to transfer ownership to another individual (e.g., to the beneficiary) to avoid inclusion of the proceeds in your estate. Transferring ownership of a policy is easy: Simply complete a change of ownership form provided by your insurance company. Remember, though, that even if you transfer ownership of an existing policy to another individual, it can be included in your estate if you die within three years of the transfer.

CornerStone Financial

Whether your nest-egg is worth millions or thousands,

You and your family deserve it more than the government....

Contact:

Eric Tuttobene

President/CEO

CornerStone Financial

(615) 427-8780

IMPORTANT DISCLOSURES

The information presented here is not specific to any individual's personal circumstances.

Buy-Sell Arrangements

Buy-Sell Arrangements

Problem:

The owners of a closely held business want the business to stay with the remaining owners in the event of death, disability, or retirement of one of the owners. One of the business owners has expressed a concern that funds may not be available to buy out a deceased owner.

Prospects:

Owners of all closely held businesses including: sole proprietors, partnerships, S corporations, limited liability companies, and C corporations. Business owners that have an interest in:

• Establishing an estate tax value for the business.

• Ensuring a ready market for their business interest.

• Seeing that the business stays within the family or owner group.

• Ensuring that funds will be available to purchase a deceased owner’s interest.

Solution:

Establishing and funding a buy-sell arrangement with life insurance may be a cost-effective means to ensure the smooth transition of a departing owner. A buy-sell arrangement is an agreement in which one party agrees to buy, and another party agrees to sell, a business interest. Funding the arrangement with life insurance helps to ensure that cash will be available for the buyout, no matter when death occurs.

Additional Benefits of Establishing and Funding a Buy-Sell Arrangement:

For the departing owner or heirs:

• If properly drafted, implemented and maintained, the buy-sell agreement helps to establish the business value for estate tax purposes.

• It provides liquidity to help pay estate taxes and/or meet family income needs.

• It guarantees a buyer, providing a ready market for the sale of the business interest.

For the purchasing party(s):

• It minimizes the risk of the business being sold to outsiders and allows surviving owners and/or family members to retain control.

• Employees, creditors, and suppliers gain added security that the business will continue.

• When funded with life insurance, cash is available to help meet the purchase obligations created by the agreement.*

*For employer-owned life insurance policies issued after August 17, 2006, IRC § 101(j) provides that death proceeds will be subject to income tax; however, where specific employee notice and consent requirements are met and certain safe harbor exceptions apply, death proceeds can be received income tax-free. Life insurance proceeds are otherwise generally received income tax-free under IRC § 101(a)

CornerStone Financial

Whether your nest-egg is worth millions or thousands,

You and your family deserve it more than the government....

Contact:

Eric Tuttobene

President/CEO

CornerStone Financial

(615) 427-8780

IMPORTANT DISCLOSURES

The information presented here is not specific to any individual's personal circumstances.

Irrevocable Life Insurance Trust (ILIT)

Irrevocable Life Insurance Trust (ILIT)

One of the main reasons we buy life insurance is so that when we die, our loved ones will have enough money to pay off our remaining debts and final expenses. We also purchase life insurance to provide for our loved ones' future living expenses, at least for a while. That's why it may seem unfair that life insurance proceeds can be reduced by estate taxes. That's right--the general rule is that life insurance proceeds are subject to federal estate tax (and, depending on your state's laws, state estate tax as well). This means that as much as 40% (currently the highest estate tax rate) of your life insurance proceeds could be going to Uncle Sam instead of to your family as you intend. Fortunately, proper planning can help protect your family's financial security.

The key is ownership

Generally, all the property you own at your death is subject to federal estate tax. The important point here is that estate tax is imposed only on property in which you have an ownership interest; so if you don't own your life insurance, the proceeds will generally avoid this tax. This begs the question: Who should own your life insurance instead? For many, the answer is an irrevocable life insurance trust, or ILIT (pronounced "eye-lit").

What is an ILIT?

An ILIT is a trust primarily set up to hold one or more life insurance policies. The main purpose of an ILIT is to avoid federal estate tax. If the trust is drafted and funded properly, your loved ones should receive all of your life insurance proceeds, undiminished by estate tax.

How an ILIT works

Because an ILIT is an irrevocable trust, it is considered a separate entity. If your life insurance policy is held by the ILIT, you don't own the policy--the trust does.

You name the ILIT as the beneficiary of your life insurance policy. (Your family will ultimately receive the proceeds because they will be the named beneficiaries of the ILIT.) This way, there is no danger that the proceeds will end up in your estate. This could happen, for example, if the named beneficiary of your policy was an individual who dies, and then you die before you have a chance to name another beneficiary.

Because you don't own the policy and your estate will not be the beneficiary of the proceeds, your life insurance will escape estate taxation.

Caution: Because an ILIT must be irrevocable, once you sign the trust agreement, you can't change your mind; you can't end the trust or change its terms.

Creating an ILIT

Your first step is to draft and execute an ILIT agreement. Because precise drafting is essential, you should hire an experienced attorney. Although you'll have to pay the attorney's fee, the potential estate tax savings should more than outweigh this cost.

Naming the trustee

The trustee is the person who is responsible for administering the trust. You should select the trustee carefully. Neither you nor your spouse should act as trustee, as this might result in the life insurance proceeds being drawn back into your estate. Select someone who can understand the purpose of the trust, and who is willing and able to perform the trustee's duties. A professional trustee, such as a bank or trust company, may be a good choice.

Funding an ILIT

An ILIT can be funded in one of two ways:

1. Transfer an existing policy--You can transfer your existing policy to the trust, but be forewarned that under federal tax rules, you'll have to wait three years for the ILIT to be effective. This means that if you die within three years of the transfer, the proceeds will be subject to estate tax. Your age and health should be considered when deciding whether to take this risk.

2. Buy a new policy--To avoid the three-year rule explained above, you can have the trustee, on behalf of the trust, buy a new policy on your life. You can't make this purchase yourself; you must transfer money to the trust and let the trustee pay the initial premium. Then, as future annual premiums come due, you continue to make transfers to the trust, and the trustee continues to make the payments to the insurance company to keep the policy in force.

Gift tax consequences

Because an ILIT is irrevocable, any cash transfers you make to the trust are considered taxable gifts. However, if the trust is created and administered appropriately, transfers of $14,000 or less per trust beneficiary will be free from federal gift tax under the annual gift tax exclusion.

Additionally, each of us has a gift and estate tax exemption, so transfers that do not fall under the annual gift tax exclusion will be free from gift tax to the extent of your available exemption. The gift and estate tax exemption amount is $5,250,000 (plus any applicable deceased spousal unused exclusion amount) for 2013. Both the annual exclusion and the exemption are indexed for inflation and may change in future years.

Crummey withdrawal rights

Generally, a gift must be a present interest gift in order to qualify for the annual gift tax exclusion. Gifts made to an irrevocable trust, like an ILIT, are usually considered gifts of future interests and do not qualify for the exclusion unless they fall within an exception. One such exception is when the trust beneficiaries are given the right to demand, for a limited period of time, any amounts transferred to the trust. This is referred to as Crummey withdrawal rights or powers. To qualify your cash transfers to the ILIT for the annual gift tax exclusion, you must give the trust beneficiaries this right.

The trust beneficiaries must also be given actual written notice of their rights to withdraw whenever you transfer funds to the ILIT, and they must be given reasonable time to exercise their rights (30 to 60 days is typical). It's the duty of the trustee to provide notice to each beneficiary.

Of course, so as not to defeat the purpose of the trust, the trust beneficiaries should not actually exercise their Crummey withdrawal rights, but should let their rights lapse.

The key duties of an ILIT trustee include:

• Opening and maintaining a trust checking account

• Obtaining a taxpayer identification number for the trust entity, if necessary

• Applying for and purchasing life insurance policies

• Accepting funds from the grantor

• Sending Crummey withdrawal notices

• Paying premiums to the insurance company

• Making investment decisions

• Filing tax returns, if necessary

• Claiming insurance proceeds at your death

• Distributing trust assets according to the terms of the trust

CornerStone Financial

Whether your nest-egg is worth millions or thousands,

You and your family deserve it more than the government....

Contact:

Eric Tuttobene

President/CEO

CornerStone Financial

(615) 427-8780

IMPORTANT DISCLOSURES

The information presented here is not specific to any individual's personal circumstances.

Life Insurance Proceeds and the Alternative Minimum Tax

Life Insurance Proceeds and the Alternative Minimum Tax

What is the alternative minimum tax?

The alternative minimum tax (AMT) is a complicated tax calculation that is intended to eliminate the potential for taxpayers to report large financial profits while reporting little taxable income for federal income tax purposes, thus paying little or no tax. The AMT is essentially a separate system of taxation with its own rules and tax computation methods. It requires the taxpayer to perform a set of calculations that may result in reclaiming some of the tax breaks otherwise available to taxpayers. The AMT amount is compared to the tax liability computed under the regular income tax calculation. If the AMT amount is higher than the regular tax amount on income, the AMT becomes the tax amount due.

Who is affected by the AMT?

The AMT applies to corporations (except S corporations) as well as noncorporate taxpayers. This discussion will focus on the corporate taxpayer. Small corporations are not subject to the alternative minimum tax. A corporation qualifies as a small corporation if its average gross receipts are $7.5 million or less over the prior three-year period (although a lower threshold may apply to a corporation's first three-year period beginning after December 31, 1993). If the corporation hasn't been in existence for the entire three-year period, the test will be applied on the basis of the time during which the corporation has been in existence. When a corporation qualifies as a small corporation for purposes of the AMT, the AMT won't apply as long as the corporation's average annual gross receipts for the prior three-year period don't exceed $7.5 million.

Corporate-owned life insurance can have an effect on AMT

As part of the risk management plan for your business, your company may have bought life insurance coverage on a key employee, such as an officer, manager, or owner. Or, life insurance may have been purchased to fund a buy-sell agreement. While corporate-owned life insurance can serve a critical function at the death of a key employee, it also can cause a C corporation to be subject to the AMT or increase a C corporation's AMT liability. This doesn't mean the corporation will always be subject to the AMT if it owns life insurance--the AMT treatment of corporate owned life insurance is only one of the many factors that are part of the AMT calculation.

Tip: When buying corporate-owned life insurance for key person coverage or buy-sell agreement funding, it may be wise to keep the potential AMT liability in mind.

Proceeds payable to C corporation could trigger AMT

As a general rule, death benefits from a life insurance policy are exempt from income tax. However, when a covered employee dies and the proceeds are paid to the corporation, exposure to the AMT is increased to the extent that the death benefit exceeds the corporation's basis in the policy. The basis of the policy for AMT purposes is generally the sum of the aggregate premiums paid plus any cash value buildup in the policy that has been included in the corporation's adjusted current earnings (see below). See the worksheet Calculate the Effect of the AMT on Corporate-Owned Life Insurance for an example of the effect.

Policy cash value buildup could trigger AMT

Generally, the internal buildup of the cash value within a life insurance policy is not subject to income tax unless the policyowner takes lifetime distributions from or surrenders (cancels) the policy. However, if life insurance policies owned by a C corporation build cash values, the increase in cash value could cause the corporation to be subject to the AMT or increase the corporation's AMT liability. This is because the amount that the cash value buildup exceeds the premium payments for the year must be included in the adjusted current earnings calculation (ACE), which is part of the overall AMT calculation.

Is there any way to avoid the AMT triggered by the receipt of death benefits on corporate-owned life insurance?

Increase the amounts of the insurance coverage

The corporation could buy enough additional insurance on each shareholder to cover any AMT liability triggered by the receipt of the death benefit. The amount of insurance needed to still have enough money after the AMT can be calculated in advance. See the worksheet Calculate the Target Amount of Insurance to Offset AMT for an example. An increase in insurance will ensure that the after-tax amount of the proceeds is sufficient, but such a strategy can be difficult if any of the shareholders are uninsurable. This doesn't avoid the AMT, but it allows for advance planning and coverage of the tax liability.

Caution: While this sounds acceptable in theory, there may be an underwriting concern. The business would likely have to provide justification (and possibly medical evidence of insurability) for the additional insurance amount applied for. Check with your insurance advisor.

Elect to become an S corporation

The AMT does not apply to S corporations. While changing the form of entity may be an option in certain circumstances, it may not be the best choice because of all the tax and legal effects involved in changing the corporate structure

CornerStone Financial

Whether your nest-egg is worth millions or thousands,

You and your family deserve it more than the government....

Contact:

Eric Tuttobene

President/CEO

CornerStone Financial

(615) 427-8780