CLU Planning for Business Owners Questions and Answers

Question 1

Three equal partners in a C-corporation have a cross-purchase buy-sell agreement funded by life insurance. If one partner dies, which of the following accurately describes the income tax consequences for the two surviving partners?

Accepted Answer

The death benefit is received income tax-free, and the surviving partners receive a step-up in basis for the shares they purchase from the deceased partner's estate.

Answer

In a cross-purchase buy-sell agreement, the partners own policies on each other. The death benefit proceeds are received income tax-free under IRC Section 101(a). When the surviving partners use these proceeds to buy the deceased partner's shares, the purchase price becomes their new basis in those specific shares. This 'step-up' in basis is a key advantage of the cross-purchase structure, as it reduces potential capital gains if the survivors later sell the acquired shares or the entire business.

Question 2

A closely held corporation wants to provide liquidity to the estate of its majority shareholder upon her death to cover estate taxes and administrative expenses. Which of the following allows the corporation to redeem a portion of the decedent's stock without the distribution being treated as a dividend?

Accepted Answer

A Section 303 Stock Redemption

Answer

IRC Section 303 allows a corporation to redeem stock from a deceased shareholder's estate to pay for federal and state death taxes, funeral costs, and administrative expenses, treating the transaction as a sale or exchange (capital gain) rather than a dividend. This is a significant exception to normal redemption rules. To qualify, the value of the stock must exceed 35% of the decedent's adjusted gross estate, among other requirements.

Question 3

XYZ Corp. provides a 'double bonus' Section 162 executive bonus plan to its CEO. The plan funds a life insurance policy with an annual premium of $50,000. Which statement is TRUE regarding the tax implications of this arrangement?

Accepted Answer

The corporation can deduct the bonus paid to the CEO, and the CEO reports the bonus as taxable income.

Answer

Under a Section 162 plan, the bonus paid to the executive is treated as compensation. Therefore, it is tax-deductible for the corporation (assuming it's reasonable compensation) and is included in the executive's gross income, subject to income and payroll taxes. A 'double bonus' or 'gross-up' bonus means the employer pays an additional amount to cover the executive's tax liability on the bonus, ensuring the net amount is sufficient to pay the full policy premium.

Question 4

A company establishes a split-dollar life insurance plan where the employee is the owner of the policy, and the employer's premium payments are secured by an interest in the policy's cash value and death benefit. This arrangement is best described as which of the following?

Accepted Answer

A collateral assignment method plan

Answer

In a collateral assignment split-dollar arrangement, the employee (or a trust) owns the policy. The employer's contributions (premiums) are treated like a loan, and the employer secures its interest by taking a collateral assignment on the policy's cash value and death benefit, ensuring repayment of its outlays upon termination of the plan or the insured's death. This contrasts with the endorsement method, where the employer owns the policy.

Question 5

Which of the following is a primary characteristic of a non-qualified deferred compensation (NQDC) plan?

Accepted Answer

It can discriminate in favor of highly compensated employees and benefits are subject to the claims of the employer's creditors.

Answer

Non-qualified deferred compensation plans are not subject to the strict ERISA participation and non-discrimination rules that govern qualified plans like 401(k)s. This allows employers to offer them exclusively to a select group of management or highly compensated employees. A key feature (and risk for the employee) is that the assets are not formally funded in a protected trust; they remain general assets of the employer and are subject to the claims of its creditors in case of bankruptcy or insolvency.

CLU - Chartered Life Underwriter Practice Test

CLU - Chartered Life Underwriter Practice Test

CLU Planning for Business Owners Questions and Answers