CSD can be used in several ways. It can be used to fund tax-free retirement income, or to provide insurance to fund a buy-sell agreement. CSD also allows a retiring physician, who is selling their Ambulatory Surgical Center(s) to convert a significant portion of the sale proceeds into tax-free income or cash.
Underlying CSD is a legal opinion providing a blueprint for borrowing an uncollateralized loan from a bank to supercharge a life insurance policy. By early funding an investment grade policy, the cash values grow much faster than is the case with traditional insurance funding. The policy cash values are then used to provide benefits. The policy is owned by the Dr., but the premiums and all interest on the loan are paid by the LLC and are tax-deductible. The buy-sell agreement can call for policy cash values to be used to offset the purchase price in a living buy-out.
The typical CSD plan is funded over the first five years. The loan grows in the life insurance policy, income tax-free, under IRC Section 72. During the term of the loan, the LLC can tax-deduct the annual interest cost on the loan. The loan interest rate is set at prime plus 1%. Assuming the policy performs at historical crediting rates, the net result should be significant growth at the end of 15 years. The loan at that point is repaid tax-free from the life insurance policy. SEE “KEY ELEMENTS” DIAGRAM.
Capital Split Dollar contemplates two loans with the same money; 1) the LLC first borrows from an outside lender, and 2) then loans the proceeds to the physician to supercharge the policy. The loan is fully secured by the life insurance policy, so there is no collateral required.
By borrowing to fund the buy-out policy, the LLC avoids any strain on working capital or retained earnings. The loan is considered a “contra loan” for GAAP purposes and is not included in the debt equity ratio of the LLC. SEE “HOW CS$ WORKS” DIAGRAM.
What is the price tag to the Physician? The physician is required to pay, either directly, or indirectly two costs. One is a small base premium during the term of the loan. By paying this, the Dr. can be assured the income from the plan will be tax-free. In addition, the IRS requires the physician to pay taxes on the value of the loan. This is calculated from Table (6) that the IRS provides. Although no interest has to be paid directly, there is a nominal tax on the imputed interested based on the size of the loan.
What are the benefits to the Physician? The physician enjoys a substantial life insurance tax-free death benefit from the plan to provide liquidity to fund buy-sell agreements, to protect his/her family, or pay outstanding debts or estate taxes. Further, policy cash values can be used to provide a tax-free lump sum living buy-out and/or a tax-free retirement income.
Once the funding period (typically 15 yrs.) is complete, the loan is repaid tax-free from policy cash values. All the growth belongs to the physician. SEE “LOAN REPAYMENT” DIAGRAM.
What are the benefits to the LLC? CSD allows the LLC to fund buy-sell agreements and living buy-outs on a tax-deductible basis. The LLC owners can pick and choose participants. ERISA or DOL regulations do not apply. No section 415 limitations. Section 409A is inapplicable.
Can CSD be used for estate planning? Yes. However, the policy should be owned by someone other than the physician, like a family member, or an Irrevocable Life Insurance Trust (ILIT).
Can the policy be isolated from bankruptcy proceedings? Yes. Actually some lenders require it. By the use of a Special Purpose Entity (SPE) at the LLC level, and a Bankruptcy Remote Insurance Trust (BRIT) at the physician level, the policy would be protected for both the LLC and physician/owner. This feature can be very attractive to the LLC (and physicians) that are particularly exposed to litigation.
Who can participate in the CSD Plan? Any physician/owner of the LLC. In addition, any non-owner key employees can be included as a golden handcuffs program to attract, reward and retain key employees.
Bottom line: If the LLC pays 100% of the annual costs, they are 100% deductible to the LLC. Only about 30% of the annual cost is includible as income to the physician and is therefore taxable to the physician. All distributions are tax-free under current law.
For more information contact BMI Consulting, LLC at (414)339-5338 and ask for Tom Lawton, tom@btagroup.net 15520 Rockfield Blvd. Suite G Irvine, CA 92618 http://www.bmiconsulting.com
Capital Split-Dollar Plan® is Patent Pending and Trademarked
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