CEA Business Succession Planning 3 — Questions and Answers
Question 1: Which of the following trust structures allows a business owner to freeze the value of an interest while transferring future appreciation to heirs at little or no gift tax?
- Qualified personal residence trust (QPRT)
- Intentionally defective grantor trust (IDGT) (Correct answer)
- Charitable lead annuity trust (CLAT)
- Spendthrift trust
Correct answer: Intentionally defective grantor trust (IDGT)
An IDGT is treated as owned by the grantor for income tax purposes but not for estate tax, allowing installment sales to the trust to shift future appreciation gift-tax free.
Question 2: When a family limited partnership (FLP) is used in succession planning, which IRS challenge is MOST commonly raised?
- Failure to file Form 706 on time
- Inclusion of FLP assets in the gross estate under IRC Section 2036 (Correct answer)
- Undervaluation of the general partner's interest
- Violation of the passive activity loss rules
Correct answer: Inclusion of FLP assets in the gross estate under IRC Section 2036
The IRS frequently argues that FLP assets should be pulled back into the gross estate under Section 2036 when the transferor retained control or economic benefit.
Question 3: Which term describes the agreed-upon formula or method written into a buy-sell agreement that determines the purchase price when a triggering event occurs?
- Redemption clause
- Price-fixing mechanism
- Valuation method (Correct answer)
- Transfer restriction
Correct answer: Valuation method
The valuation method — whether fixed price, formula, or appraisal — determines how the business interest will be priced at the time of a triggering event.
Question 4: A self-canceling installment note (SCIN) differs from a standard installment note primarily because:
- Interest is not required to be charged
- The remaining balance is canceled at the seller's death with no estate tax inclusion (Correct answer)
- It must be secured by business assets equal to the note amount
- Payments are deductible by the buyer as business expenses
Correct answer: The remaining balance is canceled at the seller's death with no estate tax inclusion
A SCIN automatically cancels upon the seller's death, removing the remaining balance from the gross estate — in exchange for a risk premium added to the price or rate.
Question 5: In the context of business succession, 'key-person insurance' is primarily used to:
- Fund a buy-sell agreement between co-owners
- Indemnify the business for lost revenue and transition costs if a critical employee dies or becomes disabled (Correct answer)
- Provide retirement income to the insured key person
- Satisfy estate tax obligations on the business interest
Correct answer: Indemnify the business for lost revenue and transition costs if a critical employee dies or becomes disabled
Key-person insurance protects the business entity itself from financial losses caused by the death or disability of a vital contributor whose skills drive revenue.
Question 6: Under IRC Section 6166, an executor may elect to pay estate taxes attributable to a closely held business interest in installments over a maximum of how many years?
- 5 years
- 10 years
- 14 years (Correct answer)
- 20 years
Correct answer: 14 years
Section 6166 allows qualifying estates to defer estate tax for up to 5 years and then pay in up to 10 annual installments, for a maximum period of 14 years.
Question 7: Which of the following business succession strategies is MOST appropriate when the owner wants to transfer the business to family members who lack the capital to purchase it outright?
- Third-party sale at fair market value
- Gifting interests using the annual exclusion and lifetime exemption over time (Correct answer)
- An ESOP funded by a bank loan
- A charitable remainder unitrust (CRUT)
Correct answer: Gifting interests using the annual exclusion and lifetime exemption over time
Systematic gifting of business interests using the annual gift exclusion and lifetime exemption allows intra-family transfers without requiring the recipients to have purchase capital.
CEA Business Succession Planning 3
Which of the following trust structures allows a business owner to freeze the value of an interest while transferring future appreciation to heirs at little or no gift tax?