If you are an owner of a closely
held business, what would happen if you or a co-owner were to
die suddenly? Whether a business is set up as a corporation,
partnership, or limited liability company, major problems can
result from the loss of one of the owners. How would the decedent’s
heirs liquidate the business interest to pay expenses and taxes?
What would happen if an heir or an unknown outside buyer of the
decedent’s share decides to interfere with the business?
Could the business or other owners afford to buy back the decedent’s
ownership interest?
Every business owner should consider these
(and other) questions — and
potential answers. An answer for many closely held businesses: a “buy-sell
agreement.”
Advantages
This type of arrangement can provide many advantages
for businesses facing the potential effects of an owner’s
death. A buy-sell agreement can:
- Guarantee a purchaser for a potentially
difficult-to-market asset (the deceased owner’s share
of the operation);
- Provide liquidity to a deceased owner’s
estate;
- Protect the remaining shareholders or
partners from unwanted interference in the business from
heirs or
third parties to whom
an heir might sell the decedent’s business interest;
and,
- Peg
the value of the deceased owner’s business interest
for federal estate-tax purposes (either by setting a value
or a way to determine the value).
Three Varieties
Generally speaking, there are three
types of buy-sell agreements. The first is a “cross-purchase” agreement.
Under this approach, the owners agree to purchase each other’s
share of the business in the event of death. If there are many
owners, this arrangement can get rather unwieldy. Under the
second variation, called a “stock redemption” agreement, the owners
agree that their corporation will buy a deceased owner’s shares. With
the third variation, a “combination” agreement, elements from the
other two types of agreement are combined. For example, individual owners could
agree to buy some of a decedent’s shares, with the company buying the
remainder.
Tax Traps
No matter which type of buy-sell agreement
is chosen, however, certain key tax issues should be addressed.
If the buy-sell agreement is properly structured,
it will fix the estate-tax value of the decedent’s share of the business,
no matter what the fair market value of that interest might be. This can provide
certainty in the owners’ estate planning. However, there are many tax
pitfalls to avoid, and failure to follow the tax law’s rules can result
in the loss of this tax advantage.
Moreover, even if a buy-sell agreement is set up
so that the IRS will likely accept the agreed-on value as the
estate-tax value, there are other considerations that should
be taken into account. For example, how will the agreement affect
the tax and estate plans of the decedent’s family and the
remaining owners? By weighing all the factors, a buy-sell agreement
can benefit all of the parties involved.
Funding of the buy-sell
agreement also needs to be closely reviewed. Most buy-sell arrangements
are funded by life insurance. Making sure that life insurance
is
properly utilized is a key element to securing all the tax benefits offered by
the arrangement.
The planning professionals of Security
Mutual Life Insurance Company of New York can provide invaluable
assistance
with the
implementation of your company’s
buy-sell agreement. Contact us today for a consultation. (Legal
Notice)
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