FAQs About Insurance
How can a buy-sell agreement protect my business?
You and your business partner(s) are a team, working hard every day to meet the many demands of running a business. Teamwork has been a major part of the success of your business. You share a vision of how to run the business, where the business is going and how to get there. It's pictured in the mind of each of you. But what if an illness or injury took one of you out of the picture?
Events like the death, disability, or retirement of an owner don't have to mean the end of the business. Business succession planning can provide for an orderly transition of ownership and business management, during lifetime or at death. One tool used in business succession planning is the buy-sell agreement. Properly designed and funded, this plan can determine who will take over the business and at what value. An owner will know that at retirement, or an earlier date, the business can be sold on a predetermined basis, thereby providing a ready market and a source of funds for the owner. In the event of the owner's death prior to retirement, the buy-sell agreement can provide for estate taxes and the surviving family's needs.
A buy-sell agreement may be established in several ways. The two most commonly used methods are a cross purchase or an entity purchase agreement.
Where there are a limited number of business owners, a cross purchase is often the favored approach. This is due to the favorable tax consequences this approach provides.
Under a cross purchase agreement, the estate of the deceased owner sells the business interest to a surviving business associate in exchange for the insurance proceeds. Each owner is legally obligated to buy the interest of his or her co-owners. Remaining owners receive a step-up in tax basis in the business.
When a cross purchase buy-sell agreement is funded using life and/or disability insurance, each owner maintains a policy on their co-owners. Since the individual owners, not the business, own these policies death benefits are tax-free and are not subject to alternative minimum tax at the corporate level. Insurance cash values can be used to fund a buyout during the lifetime of one of the co-owners.
While a cross purchase agreement is generally more favorable, the administration of this plan becomes quite cumbersome as the number of owners increases.
Under an entity purchase agreement, the business, not the owners themselves, agrees to purchase a deceased owner's business interest. Instead of co-owners maintaining a policy on each other, the business maintains only one policy on each owner.
There are some taxation differences between a cross purchase and entity purchase. Under both arrangements the death benefit proceeds, whether payable to an individual or the business, are exempt from the federal income tax. In some situations, however, a C corporation may be subject to the corporate alternative minimum tax on part of the proceeds it receives under an entity purchase. Also, under the entity purchase plan, there is no step-up in basis for a surviving owner's business interest, which is the case with the cross purchase plan. While there are many more factors to consider when developing a buy-sell agreement, this article has provided you with an overview of the two most widely used alternatives. Your next step should be to meet with your attorney, accountant, and insurance agent to begin preparations for your business succession plan.
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