8856. Can the use of life insurance to fund a cross-purchase buy-sell agreement cause the premiums to be treated as constructive dividends to shareholders in a closely-held C corporation? How can this result be avoided?Alexis Longrcline212015-07-30T19:21:00Z2015-07-30T19:21:00Z24672665Summit Business Media2263126148856. Can the use of life insurance to fund a cross-purchase buy-sell agreement cause the premiums to be treated as constructive dividends to shareholders in a closely-held C corporation? How can this result be avoided?Unless the transaction is properly structured, funding a cross-purchase agreement with life insurance can result in adverse tax consequences if the corporation pays the policy premiums. In the case of a cross-purchase buy-sell agreement between individual shareholders, a shareholder will often purchase life insurance on the lives of the other shareholders in order to fund the agreement (see Q 8855). In many cases, however, the premiums are paid out of corporate resources.In the C corporation context, these premium payments may be treated as distributions with respect to stock in the corporation for tax purposes. As a result, the shareholders will be taxed on the premiums paid as though the premiums were dividends that were constructively received by those shareholders..See, for example, Johnson v. Comm., 74 TC 1316 (1980). To avoid this result, as long as the corporation itself has no ownership rights or beneficial interest in the policy, it is possible that the corporation could instead pay the policy premium to the policy owner in the form of a bonus. In this case, the shareholders can avoid the constructive dividend tax issue and the corporation will be able to deduct the cost of the premiums paid so long as the payments can be characterized as “reasonable compensation.”.IRC Sec. 162(a), Treas. Reg. §1.162-7. Reasonable” compensation is “such amount as would ordinarily be paid for like services by like enterprises under like circumstances. The circumstances to be taken into consideration are those existing at the date when the contract for services was made, rather than those existing at the date when the contract is questioned”.Treas. Reg. §1.162-7(b)(3). A salary that exceeds what is customarily paid for such services is considered unreasonable or excessive. If the total amount paid to and on behalf of a stockholder-employee is an unreasonable return for his or her services, the IRS may treat the premium payments as a distribution of profits or dividends rather than as compensation. This also may be the result where there is no evidence, such as board of directors’ meeting minutes, to show that premium payments were intended as compensation..See, for example, Boecking v. Comm., TC Memo 1993-497; Est. of Worster v. Comm., TC Memo 1984-123; Champion Trophy Mfg. Corp. v. Comm., TC Memo 1972-250. The deduction will be disallowed where surrounding circumstances affirmatively show that premiums were not paid as compensation. In Atlas Heating & Ventilating Co. v. Comm.,.18 BTA 389 (1929). for example, evidence showed that premiums actually were paid to fund a stock purchase agreement between individual stockholders. Consequently, they were not compensation, but dividends. The policies were owned by the stockholder-employees and proceeds were payable to their personal beneficiaries. The insured individuals had agreed that, on each of their deaths, an amount of stock equal to the proceeds received by the deceased insured’s beneficiaries would be turned in to the corporation and then distributed pro rata to the surviving stockholders.See Q 8852 to Q 8859 for a discussion of buy-sell agreements in the context of C corporations generally.