At some point in time, every partner, shareholder and employee in a closely held enterprise wonders what would happen if one of life’s unexpected curve balls strikes a principal. Most principles in closely held concerns wonder what would happen to their life’s work and their families if they were prematurely deceased. We do not like to consider our mortality, but life is real and death due to accident or illness is always a possibility.
A popular remedy for these concerns is the buy-sell agreement funded with life insurance. This agreement ensures partners, employees, customers, suppliers and family members that the business will be capitalized for survival if the unexpected occurs.
There are two types of life insurance-funded, buy-sell agreements: the cross purchase plan and the stock redemption plan. The principles of the enterprise use life insurance policies to ensure that the business will be an ongoing concern after the demise of a partner of shareholder.
In addition to a funding mechanism, these plans provide a viable succession plan. As you will also see, they can and should be considered part of a retirement plan.
The Cross Purchase Plan
With a cross purchase plan, two or more owners of a closely held enterprise enter into a buy-sell agreement for their shares of the business. Each partner purchases life insurance policies on each other. The life insurance policies are payable to the other policy-holding partners. When a partner dies, the death benefit must be used by the policyholders to buy the deceased partner’s share from his or her estate.
The Stock Redemption Plan
Under this type of life insurance-funded buy-sell agreement, the company buys a life insurance policy for each of the principles. In this plan, the business pays the premiums and is the only beneficiary. Under the terms of the buy-sell agreement, the company is then authorized to purchase the deceased’s shares of the business from the estate for the predetermined price. This is a plan that many closely held businesses use to transfer ownership to employees, or key personnel, upon the demise of the principal.
For principles who want their businesses to survive regardless of what happens to them, these plans offer excellent choices.
Benefits of Buy-Sell Agreements with Life Insurance
- Shows the marketplace that there is a viable succession plan in the event the principal(s) dies.
- Prevents transfer of shares to potential heirs-shareholders who have no interest in or acumen for the enterprise.
- Provides cash, lump sum death benefit to the deceased partner’s heirs in the form of shares purchased by the surviving partners or business.
- Preserves a corporations integrity by:
- Preventing ownership by more than 75 shareholders.
- Complying with one-class-of-stock laws.
- Preventing ineligible shareholders from acquiring shares.
- Creating an excellent means to set a value for shares in closely held enterprises.
Buy-Sell Agreements Funded With Life Insurance and The IRS
The IRS never goes away, does it?
Fortunately, the agency is familiar with life insurance-funded buy-sell agreements. The principles should seek legal and accounting advice before finalizing any agreement. However, the IRS recognizes the buy-sell agreement funded with life insurance as a viable, business succession arrangement.
Because every life insurance-funded buy-sell agreement is unique, participants must get solid accounting advice to structure the most tax-advantageous plan.
To learn more about buy-sell agreements funded by life insurance, or about any general or life insurance product such as auto or homeowner’s insurance, call Jason D. Brown, your Certified Insurance Counselor at 740-998-5544. You’ll get obligation-free, straight talk and straight answers.
We at Donahue-Stangle-Brown and Cope Insurance Agency are an independent insurance agency that represents several insurance companies here in Ohio. Let us do your insurance shopping for you. We offer a wide range from auto insurance,home insurance, business insurance, business auto insurance, life insurance andfarm insurance. Please contact one of our professionals today at 740-998-5544 in Frankfort or 937-981-2272 in Greenfield. You are also welcome to contact us via EMAIL.