The answer is yes. The first step is to create a partnership/LLC or use an existing partnership/LLC to own and maintain the policies. The policies owned by the partnership/LLC will be used to fund the buy-sell agreement for the primary business which is usually structured as a corporation. The partners in the partnership/LLC are also shareholders in the corporation. As part of the initial capital contribution to the partnership/LLC, each of the partners purchase a life insurance policy and then transfer it to the partnership/LLC or the entity could purchase the policies on the partners inside the partnership/LLC. The insured partner pays the ongoing premiums on the policy as additional capital contributions to the partnership/LLC. The source of the funds used to pay the premiums can be from personal funds or can be through a salary bonus from the corporation.

When transferring a life insurance policy the transfer-for-value rules must be reviewed. This scenario, i.e. using a partnership/LLC to hold the life insurance policy, may fall under the exceptions to the transfer-for-value rules. One of the exceptions to this rule is where there is a transfer-for-value to a partnership/LLC in which the insured is a partner or where there is a transfer-for-value to a partner of the insured.

Upon the death of a partner, the partnership/LLC will use a portion of the life insurance proceeds to purchase the decedent’s partnership/LLC interest and the rest is distributed to the remaining partners to purchase the decedent’s shares in the corporation or they could contribute the proceeds to the corporation and then the corporation could redeem the decedent’s shares.

The surviving partners’ basis in the partnership/LLC increases by the amount of the allocated insurance proceeds. This allows for an income tax-free distribution of the proceeds to the surviving partners and then they can use these funds to purchase the decedent’s shares in the corporation.

If the partner lives to retirement or decides to withdrawal from the partnership/LLC the life insurance policy can be distributed from the partnership/LLC without triggering the taxation of gain in the policy’s cash value because of the non-recognition rule that applies when appreciated property is distributed from a partnership.

It would also be possible for the retiring partner to transfer his partnership/LLC interest to his irrevocable life insurance trust (ILIT) and then have the trust liquidate the partnership/LLC interest in exchange for the policy. This scenario would avoid the three-year rule for transferring existing life insurance policies to an ILIT.