Comprehensive estate planning can be an extremely complicated process for an individual. This is even more true when the individual owns a business. The owners of closely held businesses own businesses with a limited number of shareholders and the stock in such businesses is not regularly traded publicly. While this type of business can provide many benefits for business owners, it can also create issues when one of the business owner dies. However, structuring a buy-sell agreement for a closely held business can help make estate planning easier when it comes to your interest in such a business.
Redemption Agreements
With a redemption agreement, the company itself purchases a life insurance policy on the various owners of the company. When one of those owners die, the sole owner of the life insurance policy – in this case, the company – will receive the benefits of the life insurance policy and can buy back the deceased shareholder’s shares. There are some potentially negative tax consequences for this type of arrangement, including the possibility of the business to be subject to the current corporate alternative minimum tax on the proceeds from the life insurance policy.
Cross Purchase Agreements
With a cross purchase agreement, each of the individual owners of a closely held business will purchase life insurance policies on the other owners of the business. When an individual owner passes away, the remaining owners can use the proceeds from the life insurance policy held on the deceased owner to ensure that they have enough assets to purchase the deceased owner’s share sin the company. These arrangements can help a business avoid tax penalties because any benefits from the policies associated with this type of arrangement will be distributed to individuals and will likely be tax free.
It is easy to see how this type of arrangement could become confusing. If there are three owners of a business, this type of arrangement would require six separate life insurance policies. However, as the number of owners increases, the number of life insurance policies required with this arrangement can also increase exponentially. You can avoid the need for myriad life insurance policies crossed between various owners by designating a trustee who will be the owner and beneficiary of a life insurance policy taken out on each individual owner. The trustee would then be obligated to utilize the life insurance policy benefits to purchase the deceased owner’s shares and distribute them to the company, other owners, or in such a way that the agreement with the trustee directs.
Determining the Right Agreement for You
There are benefits and potential consequences associated with each of these arrangements. Neither will work well in every situation, so determining which arrangement is best for you is an important part of the process. Whichever agreement you choose, you should make sure that the agreement accomplishes the following important objectives:
- Sets a method for valuation of an individual’s interest in the business; and
- Determines a price for the interest in the business as well as a source of funding for purchasing the interest.
Properly structuring these types of agreements can help keep a business viable after an owner passes away, and can help ensure that your interest in a business is able to pass as you see fit. This can also help prevent conflict between your heirs and any remaining business owners. An experienced estate planning attorney can work with you on your business-related concerns and help advise you on these and other business-related estate planning strategies.