Insurance Planning

In this time of uncertainty, with the specter of potentially costly federal tax law changes looming, business owners can pursue peace of mind by rededicating themselves to an often-neglected discipline: insurance planning. 

 The proposed tax changes could be particularly thorny for pass-through businesses whose profits flow through to owners and are taxed under individual income tax. If enacted, the changes would challenge the ability of many such businesses — sole proprietorships, partnerships, limited liability companies and S corporations — to prosper and survive into the future. Insurance may be one of the best tools available to mitigate the risks posed by tax reform.   

 Tax proposals and their potential impact 

If enacted, the proposed tax law changes would impact businesses and their owners on several fronts. The changes could make it more difficult for businesses to remain profitable, threaten existing strategies for succession planning, and present a serious challenge to owners’ personal wealth. Here are just some of the legislative outcomes that business owners need to prepare for — if not in 2021 then possibly in 2022: 

 A higher top individual income tax rate that kicks in at lower income levels. The Biden administration has proposed a top individual income tax rate of 39.6%, up from 37%. Individuals earning $452,700 and couples making $509,300 would pay the top rate, down from previous thresholds of $523,600 and $628,300 respectively. This would represent a major increase in taxes on pass-through business income. 

A dramatically reduced estate tax exemption. One of the proposed estate and gift tax changes is that the amount a person could pass on to heirs without incurring estate taxes could decline from $11.7 million to $3.5 million. For some, that would make it difficult to pass on the family business.  

Elimination of any step up in basis. Losing this tax provision would heavily increase capital gains taxes on many inherited business assets.

 Elimination of valuation discounts on transfers to family members. Minority discounts on transfers of business interests to family members would be eliminated if, after the transfer, members of the family control the business or own majority interests in the business.  

Life insurance strategies for business owners

 Realizing these changes may be around the corner, business owners can turn to insurance solutions to provide general business protection, help them stay on track with succession plans, and meet their personal financial needs. Here are three such solutions:

  ▪ Buy-sell insurance. When a company has multiple owners, the partners are wise to have a buy-sell agreement that stipulates what happens to the ownership share of a partner who withdraws from the business or dies. With the greater tax liability that some of the new tax law changes are likely to create for transferring business assets, many businesses would benefit from buy-sell insurance. This is life insurance that can help fund the potentially catastrophic cost to the business of complying with the buy-sell agreement after a partner’s death and paying the related tax bill. 

 ▪ Key person coverage. Key person life insurance coverage can provide liquidity to give the company time to get through possible financial operating challenges associated with the loss of a key player, such as the primary revenue generator. Key person insurance can also enable the company to buy out the ownership interest of the deceased key person.

 ▪ Insurance as executive compensation. Life insurance can also serve as a tax-efficient form of executive compensation for owners or key employees. In light of the proposed tax law changes, providing a life insurance policy that’s earned following a vesting period can be more attractive to the executive than a straight salary increase while providing a “golden handcuff” to help retain them.    

 No time like the present

 Owners often wait too long to address business insurance needs. Once they have a heart attack or receive an unfortunate diagnosis of illness, they may be uninsurable.  

Tax reform has made it critical for business owners to get back to having an ongoing insurance discussion with their financial advisors, and the rising costs of insurance premiums has added to the urgency to putting an insurance plan in place.  

And then there’s the matter of legacy. If you have a family business and you’ve had your nose to the grindstone for years with the goal of someday passing the business on to the next generation, the last thing you want is to be forced to sell due to taxes. An estate plan with a strong insurance component can ensure your legacy endures.    

 Wills, trusts, foundations, and wealth-planning strategies have legal, tax, accounting, and other implications. Clients should consult a legal or tax advisor.