A dilemma for “asset rich, cash poor” closely held businesses in Minnesota is finding the cash to pay estate taxes and other expenses when a business owner dies without jeopardizing the ability to pass an intact business to the owner’s children.
One potential solution to this liquidity problem is to set up an irrevocable life insurance trust (“ILIT”) to own a life insurance policy on the business owner’s life.
If an existing life insurance policy owned by the business owner is transferred into the ILIT, the business owner must survive at least three years after the date of transfer for the transfer to be effective. On the other hand, if a new insurance policy is purchased by the trustee of the ILIT, then there is no three-year look back.
The ILIT both owns the life insurance policy and is the beneficiary of it. When the business owner dies, the life insurance proceeds are paid to the ILIT. Cash gets into the hands of the business owner’s estate by either borrowing money from life insurance proceeds received by the ILIT, or by selling stock or assets to the ILIT. Any stock or assets then held by the ILIT can be repurchased gradually by the business.
Ownership of the life insurance policy by the ILIT is a key consideration. When owned by the ILIT, the life insurance proceeds paid out by the insurance company at the business owner’s death are not subject to estate taxes. However, if the business owner owns the life insurance, the life insurance proceeds will be subject to estate taxes.
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