Maximizing Benefits with Partnership-Owned Life Insurance Strategies

Estate Planning with Partnership-Owned Life Insurance

In the realm of estate planning, partnership-owned life insurance can play a pivotal role. The landmark case of Estate of Knipp v. Commissioner (25 T.C. 153, 1955) set a precedent when the court determined that the decedent, who was a 50% partner in a general partnership and whose life was insured by the partnership, did not hold incidents of ownership in the life insurance policies. This ruling was significant because it meant that the decedent's estate would not face double taxation; the value of the life insurance proceeds was already accounted for within the decedent's partnership interest.

Further reinforcing this position, the IRS issued Private Letter Rulings (PLR 200947006 and PLR 200948001) in November 2009, which concluded that a decedent did not have incidents of ownership over policies on his life owned by a limited partnership, even though the only assets held by the partnership were the life insurance policies and the decedent had significant control over the corporate general partner and a trust that was a limited partner.

The Alternative to ILITs: FLPs and FLLCs

These IRS rulings suggest that Family Limited Partnerships (FLPs) and Family Limited Liability Companies (FLLCs) could serve as alternatives to Irrevocable Life Insurance Trusts (ILITs). Here are some advantages of using FLPs/FLLCs over ILITs:

1. Amendable Agreements: Unlike ILITs, the partnership or operating agreement of an FLP/FLLC can be amended, offering greater flexibility in response to changing circumstances or tax laws.
2. Control Retention: The insured cannot serve as the trustee of an ILIT without incurring estate tax consequences. However, they can maintain control by acting as the general partner or manager of the FLP/FLLC, while only owning a small percentage for estate tax purposes.
3. Family Dynamics: If relationships within the family change, the FLP/FLLC can be dissolved, allowing for the allocation of assets to estranged members while keeping the life insurance policy within the family.
4. Income-Producing Assets: An FLP/FLLC can conveniently hold income-producing assets to fund life insurance premiums, with income taxed at individual partner/member rates, unlike income held by an ILIT which may be taxed at higher rates.
5. Gift Tax Leverage: By gifting units of the FLP/FLLC rather than cash, the insured can potentially leverage their annual gift tax exclusion and lifetime gift tax exemption, assuming reasonable valuation discounts for lack of control and marketability.

Buy-Sell Planning with Partnership-Owned Life Insurance

When it comes to buy-sell agreements, particularly for corporations with multiple shareholders, partnership-owned life insurance can alleviate common issues. Traditional cross-purchase or wait-and-see buy-sell agreements can lead to complications, such as the need for multiple life insurance policies and potential transfer-for-value tax consequences upon a shareholder's death.

By forming a general partnership or LLC to own the life insurance policies, these problems can be circumvented. This structure requires only one policy per shareholder and ensures that life insurance death proceeds are specially allocated to the surviving shareholders, avoiding transfer-for-value issues. Moreover, partnerships and LLCs are not subject to the Alternative Minimum Tax, providing an additional tax advantage.

In conclusion, leveraging life insurance through FLPs or FLLCs can offer strategic benefits and flexibility not available through ILITs and corporations. These planning opportunities can be tailored to individual situations, providing a sophisticated approach to managing estate and business succession planning.

Please note that this article is for informational purposes only and is not intended as legal or tax advice. Taxpayers should consult their own legal and tax advisors to address their specific circumstances.

Sources:

• Estate of Knipp v. Commissioner, 25 T.C. 153 (1955)
• IRS Private Letter Ruling 200947006 (Nov. 20, 2009)
• IRS Private Letter Ruling 200948001 (Nov. 27, 2009)
• Internal Revenue Code Section 101(a)(2)