Businesses Need Estate Planning Too!
Small business owners should consider what will happen to the business in the event of the death of a shareholder. Typically, corporations will use a Key Man Insurance policy to fund either a Buy-Sell Agreement or Cross-Purchase Agreement among the shareholders. The following are benefits and concerns for each type of plan.
Entity Purchase Buy-Sell Plans Benefits to the Firm
- The firm is to be the owner, premium payor, and beneficiary of policies on the lives of its owners.
- The business is to use the proceeds of the policy to purchase a deceased owner s interest from his or her estate.
- Fair market value of the interest is to be established and liquidity for the owners estate created.
- The business is in a lower tax bracket than owners, effectively lowering the cost of the plan.
- Pooling of premium shares is desired when there is an age disparity among the owners.
- Survivors want a guarantee that funds will be available to purchase shares at the death of an owner.
- Stability is sought. Employees, lenders, customers, suppliers, and shareholders are more confident of business continuation after the death of an owner.
- No unreasonable compensation concerns as in the case when salaries are increased to pay life insurance premiums under a cross-purchase agreement.
- An unwanted forced sale is to be avoided.
- A smooth transition of control is desired.
Concerns for the Company
- Premium payments are nondeductible by the membership.
- The value of the business interest, as specified in the buy-sell agreement, is includible in the Member’s estate.
- Voting power could be unfavorably shifted at a member’s death.
- Insurance cash values and death benefits are subject to claims of company creditors.
- It can result in higher capital gains to surviving owners should interest be sold at a later date because no step up in basis is available.
- The firm s loss of the use of the premium payment.
Cross Purchase Buy-Sell Agreements Benefits to the Company
- There is to be an exchange of business interest for cash/notes among members or third-party buyers.
- Members seek to establish a fair market value for their business interest.
- Members are to be owners, premiums payors, and beneficiaries of life insurance policies.
- Surviving members wish to receive a step-up in basis in acquired interest, possibly resulting in tax savings at a later sale.
- Avoidance of family attribution concerns is desired.
- Life insurance cash values and death benefits are not to be subjected to the claims of company creditors.
- Premiums are to be paid by the firm, through a bonus arrangement, and treated as reasonable compensation to owners.
- An agreement is needed to continue the business after the death of a Member, free of conflicting interests.
- Surviving members want a guarantee that funds will be available at the death of an owner.
- Stability is sought. Employees, lenders, customers, suppliers, and shareholders are more confident of business continuation after the death of members.
- An unwanted forced sale is to be avoided.
- Life insurance proceeds are to be free from income taxation.
- A smooth transition of control is desired.
Concerns for the Company
- The value of business interest as stated in the buy-sell agreement is includible in a members’ estate.
- The member’s loss of use of premium payment.
- Possible unreasonable compensation concerns where salaries are increased to pay life insurance premiums.
- The member may have difficulty in paying premium.