A buy-sell agreement provides for the orderly transition of ownership interest of a business or entity on the occurrence of specific defined events. Most, business entities require a buy sell agreement and need to consider what happens if the owner or one of the partners, members or shareholders dies or becomes disabled. A Buy-Sell Agreement can provide a smooth transition of complete control and ownership to those who are going to keep the business going in the event of an occurrence.
A buy-sell agreement is entered into between the owners of a business which details what is to occur upon the death, disability, sale, retirement, termination, bankruptcy or other specified event. Typically, the buy-sell agreement provides that the surviving owner of the business will purchase the deceased or withdrawing owner's share of the operation. The agreement should set forth the purchase price to be paid or should provide a formula for determining the price. Perhaps most importantly, the agreement must have a mechanism for providing the funds needed to make the purchase.
Different types of plans:
Cross-Purchase Plan - With a cross-purchase agreement, each shareholder or owner buys a life insurance policy on each of the other shareholders. The purchaser of the policy is both the owner and beneficiary of the policies. An amount equal to the share of the purchase price set forth in the buy-sell agreement is purchased. Upon the death of a shareholder, the other shareholders are then able to use the life insurance proceeds to purchase the deceased owner's shares. This plan is difficult to administer if there are numerous shareholders that must buy a plan for each other.
Stock Redemption Plan - The corporation, rather than the stockholders, purchases the insurance policy, pays the insurance premiums and is the beneficiary on the lives of each shareholder. Upon the death of one of the stockholders, the death benefits are paid to the corporation who then buys the deceased's stock from the deceased's estate. An advantage of the stock redemption agreement is that it is easier to administer for multiple shareholders.
There are several tax consequences of each plan which must be thoroughly discussed prior to drafting an agreement.
Where will the funds come from to fund the Buy-Sell Agreement?
1. Buy life insurance to fund the policy. There may be several key advantages to life insurance in funding a buy-sell agreement:
- Complete financing guaranteed from the beginning
- Death proceeds are generally free from Federal income tax
- Cash value of life insurance can be used for a buyout due to retirement or disability
- It may be the most economical method - discounted dollars.
2. Borrow Funds.
3. Set-up a savings account within the company in anticipation of an event like this happening but, again, if you are a corporation there may be accumulated earnings tax problems and if you are not a corporation, it may be difficult to maintain a savings account or the death may occur prematurely before enough funds are available.
Should you have any questions, please, do not hesitate to contact me.
Very Truly Yours,
BANAFSHE LAW FIRM, PC
Payum Ryan Banafshe, Esq
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