Taxes and Business Decisions 347arrangement by succeeding to the ownership of the corporation. Or, their com-
pensation could be adjusted to cover the additional cost.
If the corporation is not an S corporation, however, there is an additional
consideration that must not be overlooked. Upon Morris’s death, the receipt of
the insurance proceeds by the beneficiary of the life insurance will be ex-
cluded from taxable income. However, a C corporation (other than certain
small businesses) is also subject to the alternative minimum tax. Simply de-
scribed, that tax guards against individuals and profitable corporations paying
little or no tax by “overuse” of certain deductions and tax credits other wise
available. To calculate the tax, the taxpayer adds to its other wise taxable in-
come, certain “tax preferences” and then subtracts from that amount an ex-
emption amount ($40,000 for most corporations). The result is taxed at 20% for
corporations (26% and 28% for individuals). If that tax amount exceeds the in-
come tax other wise payable, the higher amount is paid. The result of this is ad-
ditional tax for those taxpayers with substantial tax preferences.
Among those tax preferences for C corporations is a concept known as ad-
justed current earnings. This concept adds as a tax preference, three-quarters
of the difference between the corporation’s earnings for financial reporting
purposes and the earnings other wise reportable for tax purposes. A major
source of such a difference would be the receipt of nontaxable income. And the
receipt of life insurance proceeds is just such an event. Therefore, the receipt
of a life insurance payout of sufficient size would ultimately be taxed, at least
in part, to a C corporation, whereas it would be completely tax free to an S cor-
poration or the remaining stockholders.
An additional factor pointing to the stockholder cross-purchase agree-
ment rather than a corporate redemption is the effect this choice would have
on the taxability of a later sale of the corporation after Morris’s death. If the
corporation were to redeem Morris’s stock, Lisa and Brad would each own one-
half of the corporation through their ownership of 10 shares each. If they then
sold the company, they would be subject to tax on capital gain measured by the
difference between the proceeds of the sale and their original basis in their
shares. However, if Lisa and Brad purchased Morris’s stock at his death, they
would each own one-half of the corporation through their ownership of 50
shares each. Upon a later sale of the company, their capital gain would be mea-
sured by the difference between the sale proceeds and their original basis in
their shares plus the amount paid for Morris’s shares. Every dollar paid to Mor-
ris lowers the taxable income received upon later sale. In a redemption agree-
ment, these dollars are lost (see Exhibit 11.8).
SPIN-OFFS AND SPLIT-UPS
Morris’s pleasant reverie caused by thoughts of well-funded retirement
strategies and clever estate plans was brought to a sudden halt a mere two
years after the acquisition of the molding operation, when it became clear