Estate Planning Chapter 11 - Buy/Sell Agreements

Funding Buy-Sell Agreements with Life Insurance

1. Entity (stock redemption): Entity is applicant, owner, premium payer, and beneficiary of the policies on lives of business owners 2. Cross-Purchase: Each business owner is applicant, owner, premium payer, and beneficiary of policies on the other business owner's lives

Type of Corporate Buy-Sell Agreements

1. Entity (stock-redemption) Purchase Agreement: Corporation purchases decedent-shareholder interest 2. Corporate Cross-Purchase Agreement: Surviving shareholder(s) purchase(s) decedent-partner's interest

Type of Partnership Buy-Sell Agreements

1. Entity-Purchase Agreement: Partnership makes payments to estate to liquidate decedent-partner's interest 2. Cross-Purchase Agreement: Surviving partners purchase decedent-partner's interest

4 Methods for Price-Setting

1. Fixed price 2. Formula-determined price 3. Appraisal-determined price 4. Combination of the above

Advantages of a Buy-Sell Arrangement

1. It guarantees a market for the business interest 2. It provides liquidity for the payment of death taxes and other estate settlement needs 3. It makes the estate planning process more reliable for the owners because it helps peg the estate tax value of the decedent's business interest 4. It provides for the continuation of the business in the hands of the surviving owners and/or employees 5. It makes the business more attractive to creditors since a plan to continue the business is in place 6. It prevents transfers to unrelated parties 7. It helps to avoid expensive appraisals to establish a purchase price

Charateristics of Proprietorship Buy-Sell Agreement

1. One owner 2. Potential purchaser(s) - either a key employee or group of employees

General Format of Buy-Sell Agreement

1. Parties involved 2. Purpose 3. Commitments 4. Business interest description 5. Transfer restrictions during lifetime 6. Purchase price 7. Funding 8. Transfer details 9. Modification/Termination

Cross-Purchase Agreement - Corporation

Each shareholder agrees to purchase a specified percentage of the decedent-shareholder's stock at the time of death. If only a few corporate shareholders are involved, there are two primary tax advantages - 1) The sale of stock by a decedent-shareholder's estate is treated as a sale or exchange, allowing the estate favorable capital-gains treatment 2) Because the surviving shareholders are direct purchasers, each receives an income tax cost basis in his or her stock equal to the amount of the purchase price paid.

Entity-Purchase Agreement - Partnership

It is the partnership entity that becomes the purchaser in the buy-sell agreement. Technically, the partnership liquidates the interest held by the decedent-partner's estate. Both the partners and partnership are parties to the contract that provides for continuation of the partnership business by the surviving partners.

Entity (Stock Redemption) Agreement - Corporation

The corporation is the purchaser of the stock at the death of a shareholder. Each shareholder-party to the agreement binds his or her estate to transfer the stock to the corporation in exchange for the required purchase price. The corporation redeems the stock in exchange for a redemption distribution. The corporation either retires the stock or holds it as treasury stock. Each surviving shareholder's stock increases proportionately when a decedent-shareholder's stock is redeemed.

Cross-Purchase Agreement - Partnership

The individual partners are the sellers and purchasers. The partners make mutual promises to be a buyer or seller depending on the circumstances. Each partner agrees to purchase a share of any decedent partner's interest and to bind his or her estate to sell its partnership interest to the surviving partners.

Buy-Sell Agreement

The most common planning method used for the disposition and continuation of small business interests. A properly executed buy-sell arrangement assures that the estate will be able to sell its interest in the business for a reasonable price.

Tax Treatment of a Corporation Stock Redemption

Traditionally, a stock redemption is treated as a distribution of cash or property from the corporation to a shareholder and constitutes a taxable dividend to the redeemed shareholder. Under certain exceptions, a redemption may be treated as a sale or exchange subject to capital gains. It's essential to qualify the stock redemption as a sale or exchange to avoid harsh tax consequences.