CEA Life Insurance & Estate Liquidity 3 — Questions and Answers
Question 1: For a closely held business owner with an illiquid estate, life insurance most directly solves the problem of:
- Avoiding the need for a buy-sell agreement
- Providing cash to pay estate taxes without selling the business at a loss (Correct answer)
- Eliminating self-employment tax on business income
- Converting ordinary income to capital gains
Correct answer: Providing cash to pay estate taxes without selling the business at a loss
Life insurance creates immediate cash at death, allowing heirs to pay estate taxes and expenses without a forced or discounted sale of the business.
Question 2: Under a cross-purchase buy-sell agreement funded by life insurance, each partner or shareholder:
- Owns and is the beneficiary of policies on the other owners' lives (Correct answer)
- Assigns their policy to the business entity
- Names the corporation as primary beneficiary
- Funds the agreement with key-person insurance only
Correct answer: Owns and is the beneficiary of policies on the other owners' lives
In a cross-purchase agreement, each owner buys and owns a policy on every other owner, receiving the proceeds to purchase the deceased's interest.
Question 3: The income tax treatment of life insurance death benefits paid to an individual beneficiary is generally:
- Fully taxable as ordinary income
- Taxable only to the extent they exceed premiums paid
- Excluded from gross income under IRC §101(a) (Correct answer)
- Subject to capital gains tax
Correct answer: Excluded from gross income under IRC §101(a)
IRC §101(a) excludes life insurance death benefits from the beneficiary's gross income when paid by reason of the insured's death.
Question 4: The 'transfer-for-value' rule can cause life insurance proceeds to become taxable. Which transfer is an exception to this rule?
- Transfer to a friend of the insured
- Transfer to a corporation in which the insured is a shareholder (Correct answer)
- Transfer to a non-related third party for valuable consideration
- Transfer to a charitable remainder trust
Correct answer: Transfer to a corporation in which the insured is a shareholder
Transfers to a corporation in which the insured is a shareholder (or partner/co-insured) are statutory exceptions to the transfer-for-value rule.
Question 5: Which estate planning strategy uses the low interest rate environment by having an ILIT purchase life insurance with funds loaned from the grantor at the AFR?
- Grantor Retained Annuity Trust (GRAT)
- Split-dollar life insurance arrangement
- Private financing or intra-family loan to ILIT (Correct answer)
- Qualified personal residence trust (QPRT)
Correct answer: Private financing or intra-family loan to ILIT
A private loan to an ILIT at the AFR allows the trust to pay premiums while interest payments may remain within the estate, keeping policy proceeds out of the taxable estate.
Question 6: In a split-dollar life insurance arrangement under the economic benefit regime, the employee is taxed annually on the:
- Full premium paid by the employer
- Economic benefit of the current life insurance protection received (Correct answer)
- Cash surrender value increase each year
- Death benefit received by beneficiaries
Correct answer: Economic benefit of the current life insurance protection received
Under the economic benefit regime, the employee recognizes income equal to the cost of the pure life insurance protection (PS 58 or insurer's term rates) provided by the employer.
Question 7: Which settlement option allows the life insurance beneficiary to leave proceeds with the insurer and receive periodic interest payments?
- Life income option
- Fixed period option
- Interest option (Correct answer)
- Fixed amount option
Correct answer: Interest option
The interest option lets beneficiaries leave the principal with the insurer while receiving interest, retaining the right to withdraw the lump sum later.
CEA Life Insurance & Estate Liquidity 3
For a closely held business owner with an illiquid estate, life insurance most directly solves the problem of: