AEP AEP Business Succession Planning 1 — Questions and Answers
Question 1: A buy-sell agreement funded with life insurance that is triggered upon a business owner's death ensures which primary outcome?
- The deceased owner's family retains control of the business
- The surviving owners can purchase the deceased's interest at a predetermined price (Correct answer)
- The business is liquidated and proceeds are distributed equally
- All outstanding business debts are automatically extinguished
Correct answer: The surviving owners can purchase the deceased's interest at a predetermined price
A life insurance-funded buy-sell agreement provides the surviving owners with tax-free death benefit proceeds to purchase the deceased owner's interest at a pre-agreed valuation.
Question 2: In a cross-purchase buy-sell agreement among three business owners, how many life insurance policies are typically required?
- 3
- 6 (Correct answer)
- 9
- 12
Correct answer: 6
In a cross-purchase agreement, each owner insures every other owner, so with three owners the formula is n(n-1) = 3×2 = 6 policies.
Question 3: Which business succession vehicle allows a parent to transfer a family business to children while retaining an income stream and minimizing gift tax?
- Intentionally Defective Grantor Trust (IDGT) with installment sale
- Grantor Retained Annuity Trust (GRAT)
- Charitable Lead Annuity Trust (CLAT)
- Both A and B (Correct answer)
Correct answer: Both A and B
Both an IDGT installment sale and a GRAT can shift business appreciation to the next generation while the grantor retains income, making them complementary succession tools.
Question 4: For federal estate tax purposes, a closely held business interest may be eligible for a valuation discount due to lack of marketability (DLOM) and lack of control (DLOC) primarily because:
- The IRS mandates discounts for all family businesses
- A hypothetical buyer would pay less for an illiquid, non-controlling interest (Correct answer)
- Minority interests are always valued at book value
- Business assets depreciate faster than public company assets
Correct answer: A hypothetical buyer would pay less for an illiquid, non-controlling interest
Valuation discounts reflect economic reality: a hypothetical buyer would demand a lower price for an interest that cannot be easily sold and provides no ability to control business decisions.
Question 5: IRC §6166 provides estate tax relief specifically for estates with a significant closely held business interest by allowing:
- A full exclusion of the business value from the taxable estate
- Installment payments of estate tax attributable to the business over up to 14 years (Correct answer)
- A stepped-up basis on all business assets
- A charitable deduction equal to 50% of the business value
Correct answer: Installment payments of estate tax attributable to the business over up to 14 years
IRC §6166 permits estates where the closely held business exceeds 35% of the adjusted gross estate to pay the business-related estate tax in installments over up to 14 years at favorable interest rates.
Question 6: A family limited partnership (FLP) used in business succession planning primarily achieves which estate planning benefit?
- Eliminates all capital gains taxes on asset transfers
- Allows valuation discounts on transferred limited partnership interests, reducing gift and estate tax (Correct answer)
- Qualifies the family for the §2032A special use valuation
- Avoids the generation-skipping transfer tax entirely
Correct answer: Allows valuation discounts on transferred limited partnership interests, reducing gift and estate tax
Transferring limited partnership interests in an FLP allows the donor to apply DLOM and DLOC discounts, reducing the taxable value of gifts and estate transfers to family members.
AEP AEP Business Succession Planning 1
A buy-sell agreement funded with life insurance that is triggered upon a business owner's death ensures which primary outcome?