Rule Atlas
IRC § 264: Business Continuation: Key Person, Buy-Sell, and Group Benefit Strategies
Under IRC § 264 (CFP Board / IRS / SEC), business Continuation: Key Person, Buy-Sell, and Group Benefit Strategies establishes the authoritative rules tested on the CFP® Certification. Protect a business from its most critical risks. VoraPrep verifies every threshold, worked table, and practice question below against the current CFP® Certification blueprint.
Funding the Buy-Sell: A Structural Comparison
| Feature | Cross-Purchase Agreement | Entity-Purchase (Stock Redemption) |
|---|---|---|
| Number of Policies | N × (N-1) where N = # of owners | N (one policy per owner) |
| Basis for Survivors | Survivors get a step-up in basis for the shares they purchase. | No step-up in basis for the survivors' existing shares. |
| Administration | Complex, especially with many owners. | Simpler, as the business manages all policies. |
| Creditor Exposure | Policy cash values are owned by individuals, protecting them from business creditors. | Policy cash values are a business asset, exposed to business creditors. |
| Premium Equality | Potentially unequal premiums due to age/health differences among owners. | Premiums are paid by the business, effectively spreading the cost. |
David (40) and Sarah (42) are 50/50 partners in "GreenTech Solutions," a successful IT consulting firm valued at $4 million. They have a properly structured entity purchase (stock redemption) buy-sell agreement funded by life insurance policies, with the business owning a $2 million policy on each partner and naming the business as beneficiary. They review their agreement annually. Last year, David's role became highly specialized, driving 70% of the company's innovation and securing major contracts. Sarah manages operations, and the business relies heavily on David's unique expertise. Considering David's critical and specialized role, which of the following actions should the CFP® professional MOST strongly recommend to GreenTech Solutions during their annual review?
Worked Example: Calculating the Key Person Insurance Need
Scenario: Innovate Corp. has a brilliant lead software engineer, Chloe, who is responsible for developing their flagship product. The CFO estimates that Chloe's direct contribution to annual profits is $500,000. They believe it would take at least three years to find and train a replacement to her level of productivity. The company has no existing funds earmarked for this contingency.
- Here is how to calculate the insurance need:
- 1. Determine the annual financial loss. This is Chloe's estimated contribution to profits: $500,000 per year. 2. Estimate the replacement period. The company believes it will take 3 years to recover from her loss. 3. Calculate the total insurance need. This is the total financial impact over the replacement period.
- Insurance Need = Annual Profit Contribution × Years to Replace Insurance Need = $500,000 × 3 years = $1,500,000
- If you picked a value based on a multiple of Chloe's salary (e.g., 5 times her $200,000 salary = $1,000,000), you've fallen for a common misconception. While the salary-multiple method is a quick heuristic, the CFP® exam will favor the more precise method of quantifying the lost contribution to profits over the expected recovery period. Always use the profit-contribution method when the data is provided.
Common CFP® Certification Distractors on IRC § 264
- 1Use this mnemonic to keep the buy-sell agreements straight:
- 2Criss-Cross gets the Basis: In a Cross-Purchase, the basis for the purchased shares crosses over to the surviving partners, giving them a valuable step-up.
- 3Entity is Easy: An Entity-Purchase is administratively easy because there are fewer policies to manage (only N policies).
- 4To effectively advise business owner clients, a planner must master three core insurance strategies:
- 5Key Person Insurance: Protects the company from the financial loss of a critical employee. The business owns the policy and receives the tax-free death benefit.
Frequently Asked Questions: IRC § 264
What is the core rule under IRC § 264 (Business Continuation: Key Person, Buy-Sell, and Group Benefit Strategies)?
Under IRC § 264 (CFP Board / IRS / SEC), business Continuation: Key Person, Buy-Sell, and Group Benefit Strategies establishes the authoritative rules tested on the CFP® Certification. Protect a business from its most critical risks. VoraPrep verifies every threshold, worked table, and practice question below against the current CFP® Certification blueprint.
How is IRC § 264 tested on the CFP® Certification?
Use this mnemonic to keep the buy-sell agreements straight: Criss-Cross gets the Basis: In a Cross-Purchase, the basis for the purchased shares crosses over to the surviving partners, giving them a valuable step-up.
Where can I practice CFP® Certification questions on Business Continuation: Key Person, Buy-Sell, and Group Benefit Strategies?
Test yourself instantly with the free playable CFP® Certification question on this page, or launch VoraPrep's full CFP® Certification adaptive question bank, interactive lessons, and 1:1 exam simulator at voraprep.com/cfp.