The Politics of Religion As It Applies to Small Business

Ever since President Obama interjected his religious beliefs into the current political campaign with his diktat on contraception for Catholics, the main stream media (MSM) has been in a tizzy about Rick Santorum’s religious convictions.

Santorum has obliged by talking about the moral values that under gird a free democratic society.

This talk about the moral values in America by Santorum has sent the MSM into an even bigger tizzy. The media suspects that as a Catholic,just like their earlier suspicion of John F. Kennedy, there may be some Catholic cult or dark wicca practice, like Skyclad, that Santorum may implement for all Americans.

As a way of diffusing this volatile political issue, there is a path for the MSM to take to on examining how religious beliefs apply to owning and managing a small business.

Not that there is anything wrong with Skyclad.

Seeking Redemption

In a quaint play on words, the language of business buy sell insurance adopted the term “redemption” to describe one possible method for implementing and funding the insurance for a small business buy sell agreement.

In its application of Santorum’s Catholicism, redemption has a slightly different meaning, with an ancient controversy over how exactly one who believes gains redemption.

In the business case, redemption comes when the insurance policy pays out the death benefit to the business.

In this special case of redemption, the business itself, was the lost soul who got redeemed. The business did three things, (good deeds alone) to gain redemption.

1. The business applied for a life insurance policy whose total death benefit value was large enough to buy out a deceased owner’s shares from the estate of the departed.
2. The business named itself as the legal owner of the life insurance policy.
3. The business named itself as the legal beneficiary of the death benefits.

And, Voila, at the moment of death of an owner, the redemption occurs.

The Calvinists hate this whole idea of good business deeds leading to redemption, preferring instead to believe that a business is pre-ordained for redemption from birth. But, in the case of business, nothing is pre-ordained, so it is best to seek redemption from an early age.

The Act of Redemption

The corporation will not recognize income for tax purposes when it receives the insurance death benefit proceeds. (Hint to Republicans: Do not mention this business tax treatment to Obama).

The tax treatment for the business looks like a two-step tango. First, when the corporation first obtains the death benefit, it must reflect that part of the transaction on the earnings and profits of the corporation. The earnings and profits will increase with the life insurance proceeds received.

Second, and as a major act of faith, the earnings and profits decrease as a result of the stock redemption from the estate of the departed.

It takes a major act of faith, best codified by a legal agreement, for the business to buy the shares away from the estate. The legal agreement is between the company, and each owner and it legally obligates the estate to sell, and for the company to buy the shares.

The surviving owners and remaining shareholders do not get the benefit of a step-up in basis on their own shares when the corporation purchases (redeems) the deceased shareholder’s interest from the estate. The ownership interests of the remaining shareholders retain their original tax bases in the company.

The Estate of the Dearly Departed

Under a redemption approach, the estate tax consequences can become more pronounced when the deceased shareholder has a controlling interest.Under IRC section 267A, shareholder who owns more than a 50% interest either directly or indirectly is deemed to control a corporation.

In this situation, the shareholder may be deemed to have an ownership interest in the life insurance policy due to the shareholder’s ability to designate a beneficiary other than the company itself.

This is one big important reason why both legal help in drafting the agreement, and tax help in accounting for the insurance proceeds are essential. A distribution from a corporation to a shareholder or a shareholder's estate could possibly be taxed as a dividend, the preferred outcome in Obama’s philosophy.

The fact that the departed had a majority ownership could possibly result in the proceeds being includable in the deceased’s estate. Thus, the after-tax returns on life insurance policies can be substantially reduced if estate taxes are incurred as a result of the life insurance proceeds being included in the estate.

This outcome would not lead to Heaven for the estate, but to spending years in that other place, halfway between Heaven and Hell, commonly called the IRS.

The business attorney and the tax professional may qualify the transaction as a Section 303 redemption.

If the 303 requirements are met, a distribution from the business in exchange for stock will be treated as a capital transaction, and the shareholder's basis may be subtracted from the sale price. And since the basis steps up to fair market value at a stockholder's death, there is usually no difference between the basis and the sale price, so there is no gain.

Funding The Insurance Premiums for the Business Buy-Sell Agreement

The company applies for, owns, and is also the beneficiary of the insurance policy that funds the buy-sell redemption agreement.

Redemption is just one possible method of implementing the buy sell agreement, which is a legally binding agreement between owners.Sometimes, the legal agreement, which precedes the insurance policy, and the insurance policy itself, are confused and commingled.

The insurance policy requires a periodic payment of premiums. In many cases, a very beneficial outcome for the company can be obtained when the company uses business revenues to pay the insurance premium.

This payment of the insurance premium by the company requires careful deliberation from the attorneys and tax professionals who are providing guidance on implementing the redemption agreement. In many cases, it may be useful for the family to have its own legal and tax representation that is independent of the business professionals.

But, given the right set of precursor conditions, funding the insurance with business dollars sometimes leads to the seventh level of Nirvana, an incredibly blissful state, or so I am informed.

And, as is the case with Santorum’s religion, this blissful state inures to the happiness of the individual, and not the engorgement of the State.

Thomas Vass is an independent licensed insurance agent, located in Raleigh, N. C., with a special focus on helping small companies implement buy-sell agreements.

Please note: Vass is not an attorney and does not provide legal advice, and Vass is not a tax professional and does not provide tax advice. Vass is a business insurance professional and provides business insurance advice. Nothing in this article is intended to provide legal or tax advice, and any relationship to political advice is merely coincidental.