Employer X is privately held and sponsors ESOP M. If Employer X purchases COLI to fund its repurchase liability, (a) is the inside buildup on the COLI and/or (B) any death benefits on the COLI, subject to the alternative minimum tax?

I seem to recall looking at this issue many years ago, and I have a vague recollection that both items were included in the corporation's AMT calculations.

Assuming that the corporation is subject to AMT, both items are included in its Adjusted Current Earnings (ACE) under Code Section 56(g)(4)(B)(ii)(I) and Regs. Section 1.56(g)-1©(5)(v) respectively, to the extent they exceed the corporation's basis in the contract. The inclusion of ACE to the AMT calculation, however, is limited to 75 cents on the dollar. Thus, with a 20% AMT rate, you are looking at an effective tax liability of 15%.

You could, of course, avoid the AMT liability by purchasing the insurance within the ESOP, however, for reasons too numerous to address here you would almost certainly not want to do so.

Our firm specializes in the complex issues surrounding the design, implementation, and administration of financing strategies for nonqualified employee benefit liabilities (including ESOP repurchase obligations). Should you or your client require any further assistance in this area please feel free to contact me.

Eric A. Karno, JD
Vice President
Aon Executive Benefits
(404) 442-1015
eric_a_karno@aoncons.com

Is this ESOP Message Board now becoming a forum for facilitating the sale of life insurance products?

How do you use COLI to fund the liability? Who is the insured? Who is the beneficiary? Who is the owner?

If the response is too lenghty can you refer me to any cites, sites or material?

COLI would involve the purchase of whole, universal life or variable life policies by the employer as owner and beneficiary on the lives of either all the participants of the ESOP (at the time the policies are obtained) or the key employees of the employer. Death benefits could either be applied to pay repurchase liability or reinvested in the policy. If there are no death benefits available when the employer has repurchase liability, the employer could either borrow against the cash value of the policies or make withdrawals of the cash value to pay the repurchase liability. I am assuming you would know how repurchase liability arises. I hope this helps.

As a general rule:

The COLI contracts are variable products owned by the employer.

The employer is the named beneficiary.

The insureds may be a group of key employees with significant ESOP account balances or the employer may choose to insure a broad base of active ESOP participants.

The COLI serves two purposes. First, in the event of a premature death of a key employee, it provides tax-free proceeds to meet the repurchase obligation connected with that employee's ESOP account. Second, it provides a tax advantaged investment fund that may be used to finance ongoing ESOP repurchase obligations and diversification requirements. To avoid taxation, proceeds from the COLI may be withdrawn up to basis and then as tax-free loans. The idea being, that for an employer in a high tax bracket, the IRR on the tax-free COLI investments will be measurably superior to that offered by similar taxable mutual funds.