TEFRA, DEFRA, and TAMRA & life insurance 

Discover how life insurance structured under TEFRA, DEFRA, and TAMRA helped fund a tax-smart business succession plan through a buy-sell agreement. (How TEFRA, DEFRA, and TAMRA Helped My Client Fund a Seamless Business Succession Plan)

What Happens to a Business When One Owner Passes Away?

Small business partnerships are the backbone of American entrepreneurship—but few prepare for the unexpected. According to the National Association of Insurance Commissioners, more than 70% of small businesses don’t have a succession plan in place. That leaves families, employees, and co-owners exposed to serious risk.

That’s where we came in.

When John and Michael, 50/50 partners in a seven-figure logistics company, contacted The Policy Shop, they wanted a strategy that would:

1. Allow the surviving partner to buy out the deceased’s share;
2. Protect the business from sudden ownership shifts;
3. Do so without triggering unnecessary taxes or delays.

We built a cross-purchase buy-sell agreement funded by two LifeENSURE Whole Life Insurance policies, carefully structured to follow TEFRA, DEFRA, and TAMRA rules to protect tax advantages and provide cash value flexibility.

Understanding Buy-Sell Agreements and Life Insurance

What’s a Buy-Sell Agreement?

It’s a legal contract that outlines what happens if a business owner dies, becomes disabled, or wants to exit. The agreement can be entity-owned or cross-purchase, depending on who buys the deceased’s share.

Why Use Life Insurance?

A life insurance policy provides immediate liquidity—a tax-free lump sum payout—so the surviving owner can buy the other’s equity, ensuring business continuity.

TEFRA, DEFRA, and TAMRA: The Tax Laws That Made This Work

TEFRA & DEFRA: Ensuring It’s Real Insurance

Both TEFRA (Tax Equity and Fiscal Responsibility Act of 1982) and DEFRA (Deficit Reduction Act of 1984) set guidelines to ensure that life insurance isn’t used solely for investment. They test:

• The relationship between premiums paid and death benefit
• That the policy qualifies as life insurance under IRS code

In this case, both policies were tested under the Guideline Premium Test to ensure compliance.

TAMRA: Avoiding a Modified Endowment Contract (MEC)

We needed flexibility for tax-free withdrawals if either partner exited the business early. TAMRA’s 7-pay rule helped us structure the premiums to avoid MEC classification, keeping future distributions income tax-free.

Learn more in our Guide to TAMRA, TEFRA, and DEFRA.

The Policy Design: How We Structured the Buy-Sell Plan

The Policy

Each partner owned a LifeENSURE Whole Life Insurance policy on the other. Upon death, the death benefit would be used to buy out the deceased partner’s share.

Premium Strategy

We designed each policy to be fully paid up in 10 years—using level annual premiums under the 7-pay rule. This preserved long-term cash value growth without triggering MEC status.

Cash Value Bonus

The policies also built cash value, which could be accessed via policy loans if needed for business expansion, key employee bonuses, or buyout scenarios due to disability.

Key Benefits of Using Life Insurance for Business Succession

• ✅ Tax-free payout at death to fund the buy-sell agreement
• ✅ Avoids delays and valuation issues in probate
• ✅ Builds cash value that can be used for emergencies or exits
• ✅ Keeps the business in the hands of the surviving owner
• ✅ Avoids MEC status for full tax advantages

FAQs

Q: What’s the difference between a cross-purchase and an entity buy-sell plan?

A: In a cross-purchase plan, each owner buys insurance on the other. In an entity plan, the business owns and is the beneficiary of the policy.

Q: Why not just save money instead of using life insurance?

A: Life insurance provides immediate liquidity and tax-free death benefits—savings can take years to accumulate and may be subject to taxes.

Q: What if one partner wants to exit early?

A: The policy’s cash value, when designed correctly, can be used for early buyouts without penalties—as long as it avoids MEC status.

Q: Can this also work for more than two partners?

A: Yes, but it requires more policies or an entity plan. We help structure complex multi-owner agreements too.

Final Thoughts: Smart Succession Planning Starts Before You Need It

John and Michael walked away with peace of mind and a rock-solid plan. Their company continues to thrive—with clarity on what happens if the unexpected occurs. Their families are protected. Their employees are secure. And their business is built to last.

Thinking about a succession plan for your business? Schedule a free consultation to talk through your options with a licensed expert.