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Buy-Sell: Cross Purchase vs. Entity Purchase vs. One-Way

Nineteen questions you should consider when choosing a buy-sell agreement

Factors to consider Cross purchase Entity purchase One-way
What is the form of business entity? Any business with multiple owners Any business with multiple owners Business with any number of owners including sole proprietorship
Who is the buyer? Co-owner Business entity Business entity, co-owner, key employee, or any eligible third party
Who is the seller? Shareholder or family or estate of shareholder Shareholder or family or estate of shareholder Shareholder or family or estate of shareholder
Can life insurance be used to fund agreement? Yes, generally each shareholder is applicant, owner, payer, and beneficiary of life insurance on other shareholders Yes, generally business entity is applicant, owner, payer, and beneficiary of life insurance on each shareholder Yes, buyer under agreement could be applicant, owner, payer, and beneficiary on policy on life of seller
How many policies will be needed? Multiple policies needed
Formula used is:
n(n-1)n = number of shareholders
Number of policies is minimalOnly one policy per shareholder needed Number of policies is minimalOnly one policy per shareholder needed
Are the premiums deductible? Premiums are not tax-deductible expense to shareholders Premiums are not tax-deductible expense to business Premiums are not tax-deductible expense to buyer
Are death proceeds taxable? Received by surviving shareholders tax free Received by business entity tax freeAlternative minimum tax (AMT) may apply Received by beneficiary tax freeAlternative minimum tax (AMT) may apply if proceeds received by business
Are death proceeds subject to claims of creditors? In most states, death proceeds on personally owned policies are exempt from claims of creditorSome states limit amount of proceeds exempted Corporate creditors can usually claim against cash value and proceeds of life insurance owned by the business Corporate creditors can’t reach proceeds of personally owned policies, but they can claim against proceeds of life insurance owned by the business
Does business have a right to death proceeds? Proceeds available to business only if surviving shareholders willing to make loan or capital contribution Business entity has right to death proceeds when it is policy beneficiary Business entity has right to death proceeds when it is policy beneficiaryProceeds payable to individual available to business only if individual willing to make loan or capital contribution
What happens to stock basis of remaining shareholders? Basis increases by amount equal to price paid by shareholder for stock No increase in shareholder’s basisValue of stock owned by remaining shareholders increases when corporation retires stock or holds as treasury stock Basis increases by amount equal to price paid by individual for stockNo increase in shareholder’s basis for stock bought by business entity
What if co-owners are related and business is a corporation? Not an issue Attribution rules apply when stock is purchased by business entityIn family corporation, redemption of stock usually results in dividend Attribution rules apply when stock is purchased by business entity
What if there is a need to change from one type of insurance funded buy-sell to another? Transfer of existing insurance policies to corporation may be an exception to transfer-for-value rule Transfer of corporate-owned policies to shareholders violates transfer-for-value rule unless an exception applies Typically the plan would not change
Which plan has most flexibility? Agreement with multiple shareholders can be cumbersome when funded with life insuranceAdding new shareholders to plan may be complicated Can’t be used by a corporation with one shareholder or a sole proprietorshipCan add new shareholders to plan with unanimous consent to amend agreement If buyer dies before seller, seller has no obligation under agreement terms
Is value of insurance included in estate of decedent shareholder? Value of policies owned on other shareholders included in estateProceeds of policies on own life are included in estate Value of proceeds payable to business may indirectly increase decedent’s estate by increasing the value of corporation Proceeds of policy on own life not included, but business-owned policy proceeds may inflate value of corporation and decedent’s estate
Are ownership amounts or percentages affected? Remaining shareholder’s ownership percentages can remain same or change, depending on amount of stock purchased by each Ownership ratios of remaining shareholders increased pro rata by the amount of stock redeemed by business entity Buyer’s ownership percentage can remain same or change, depending on amount of stock purchased and previous ownership
Does state law apply? If professional corporation, state law restricts sale to other professional State corporate law allows a corporation to buy its own shares only from surplus fundsRedemption prohibited if it would make a corporation insolvent If professional corporation, state law restricts sale to other professional or business entity itself
Could there be a problem when transferring the policies that decedent owned on surviving shareholders? Potential transfer-for-value problem at shareholder’s death when decedent’s interest in policies is transferred to surviving shareholders If policies are owned by corporation, there is no need to transfer at decedent’s death Typically not an issue since buyer is usually only owner of policy on seller
What happens if business earnings accumulate to fund buy-sell? No corporate funds usedUsually no accumulated earnings tax issue Business funds accumulated in advance of shareholder death for purpose of stock redemption may be subject to accumulated earnings tax unless business purpose can be proven If no corporate funds used, usually not an issueIf business purpose for accumulation can be proven, may not be an issue
Are there any estate tax effects to shareholder? If the estate is bound to sell and certain conditions are met, the agreed price typically will control for federal estate tax purposesSale price included in estate If the estate is bound to sell and certain conditions are met, the agreed price typically will control for federal estate tax purposesSale price included in estate If estate is bound to sell and certain conditions are met, the agreed price typically will control for federal estate tax purposes

Sale price included in estate