Help ensure market for deceased; owner's interest Pre-determine price of ownership interest
Help avoid competing interests between heirs, business partners and surviving owners
Competing interests of heirs and surviving owners
Provide liquidity for estate
Determine a value that is binding on the IRS for federal estate tax purposes
Stability for customers, staff, creditors and investors
Mutually agreeable terms of sale
An orderly transfer of the business
Information Needed for Funding a Buy-Sell Agreement with Life Insurance
Type of entity, i.e. C Corp, S Corp, Partnership, LLC, etc.
Owner/Purchaser information - name, age, percentage of ownership, underwriting class, smoker/non-smoker
Cross-Purchase Agreement
Advantages
Increase in basis for purchasing owner
No alternative minimum tax consequencesNo dividend treatment
Disadvantages
Multiple life insurance policies may be needed for funding
Premium prices may not be equal for each owner
No increase in basis for remaining owner(s)
Income Tax consequences to Owner Cross Purchase Agreement
Generally
Premiums are paid by owners with after-tax funds
Purchasing Owner
Life insurance proceeds are generally not subject to income tax unless there has been a transfer-for-value
Basis in acquired interest is equal to purchase price
Selling Owner/Selling owner's estate
Gain or loss recognized on sale based on terminating owner's tax basis in interest. Deceased owneręs interest will generally have a step up in basis. After 2009, interest may not be eligible for full step up in basis under Economic Growth and Tax Relief Reconciliation Act of 2001 "EGTRA" of 2001.
Estate Tax Consequences -
Value of ownership interest may be fixed with a buy-sell agreement. Note there are very stringent rules for fixing estate tax values between related parties.
The policy can be arranged so that the proceeds will not be included in the insured's estate
Redemption Agreement
Advantages
Business pays for premiums
Only one Life insurance policy per owner is needed
Disadvantages
Possible Alternative Minimum Tax
Possible dividend treatment to shareholders
Income Tax Consequences to Business - Redemption Agreement
No deduction is allowed for premiums paid to fund a buy-sell agreement
Life insurance proceeds are generally not subject to income tax unless there has been a transfer-for-value
If the business is a C Corporation, proceeds and cash value increases may be subject to Alternative Minimum Tax
Income Tax Consequences to Owners - Redemption Agreement
Non-terminating Owner
No step-up in basis for non-terminating owneręs increased interest
Terminating Owner
Possible dividend treatment at buyout if business is a corporation unless certain conditions are met
Gain or loss recognized on sale based on terminating owner's tax basis in interest. Decreased owner's interest will generally have a step up in basis. After 2009, estate may not be eligible for full step-up in basis under EGTRA of 2001
Estate Tax Consequences:
Value of ownership interest may be fixed with a buy-sell agreement. Note there are very stringent rules for fixing estate tax values between related parties.
Life insurance proceeds are not directly included in the insured's estate when the business is the owner and beneficiary
Wait-and-see/Hybrid Agreement
A "wait-and-see" or hybrid agreement is generally drafted so that the business has the first option to purchase a terminating owner's stock. If it doesn't purchase all of the stock, the remaining owners have an option to do so. If they fail to purchase all of the remaining stock, the business is required to purchase what's left.
Tax consequences depend on the approach actually executed i.e. entity purchase or cross purchase.
