A buy-sell agreement is an important tool that all small business owners should consider to ensure a smooth transition of their business at their retirement or death. Without proper planning, the sudden death of a small business owner may have a devastating impact on the business, the business’ employees, and the other owners of the business. It may also have a significant financial impact on his/her family. A properly structured business continuation plan (i.e. a buy-sell agreement) funded with life insurance may help to minimize the impact caused by the loss of a business owner for both the business and the business owner’s family.
CROSS PURCHASE
- Agreement: Working with the business legal, tax and financial advisors, the business owner and his/her co-business owner(s) enter into a cross purchase agreement. The agreement will require the business owners to purchase a decedent or departing business owner’s interest in the business for an agreed upon price upon the occurrence of a triggering event (e.g. death, retirement or disability)
- Premium: To fund their purchase obligation, the business owners will purchase a life insurance policy (or life insurance policies) through a life insurance professional on the lives of the other participating business owners. The policyowner will pay the policy premiums and will be the policy beneficiary.
- Death Benefit: At the first business owner’s death, the co-business owners will receive the life insurance death benefit income tax-free*
- Stock Purchase: The co-business owners will apply the death benefit proceeds towards the purchase of the decedent business owner’s interest in the business from his/her estate.
Information above provided by Pacific Life. Neither Ron Schutz-Planning Business Transitions, LLC, Pacific Life nor World Equity Group, Inc provide tax or legal advice. Please consult your independent tax & legal advisor.
*For federal income tax purpose, life insurance death benefits generally pay income tax-free to beneficiaries pursuant to IRC Sec. 101(1)(1). In certain situations, however, life insurance death benefits may be partially or wholly taxable. Situations include, but are not limited to: the transfer of a life insurance policy for valuable consideration unless the transfer qualifies for an exception under IRC Sec 101(a)(2) (i.e. the “transfer-for value rule”); arrangements that lack an insurable interest based on state law; and an employer-owned policy unless the policy qualifies for an exception under IRC Sec. 101(j).