Chapter 10: Buy-Sell Agreements Flashcards
Most properly drafted buy-sell agreements have several common provisions, regardless of
the specific type of agreement. Common terms of a typical buy-sell agreement include the
following:
1) Parties involved
2) Purpose
3) Commitment (obligations of parties involved)
4) Business interest description
5) Transfer restrictions during lifetime
6) Purchase price
7) Funding
8) Transfer details
9) Modification/termination
Types of Partnership Buy-Sell Agreements
Types of Partnership Buy-Sell Agreements
• entity-purchase agreement
- partnership makes payments to the estate to liquidate the decedent-partner’s interest
• cross-purchase agreement
- surviving partners purchase the decedent-partner’s interest
Entity (Liquidation) Agreement
The entity buy-sell approach, or entity (liquidation) agreement, provides that the partnership will liquidate the interest of a decedent-partner at death.
Cross-Purchase Agreement
The cross-purchase agreement provides that the surviving partners are obligated to buy a prearranged share of a decedent-partner’s interest from the
decedent’s estate. The agreement is usually funded by life insurance policies owned by the individual partners. Each partner should purchase life insurance policies on the lives of the other partners whose deaths obligate the policy owner to purchase the decedent’s partnership
interest.
A Closely Held Corporation
A corporation is a legal entity separate from its shareholders. It provides limited liability to its shareholders and is treated as a separate taxpayer with tax rates and rules quite different from those applicable to individual taxpayers.
Types of Closely Held Corporation
Buy-Sell Agreements
• entity (stock-redemption) purchase agreement
• corporate cross-purchase agreement
Types of Closely Held Corporation
Buy-Sell Agreements
• entity (stock-redemption) purchase agreement
- corporation purchases decedent-shareholder’s interest
• corporate cross-purchase agreement
- surviving shareholder(s) purchase(s) decedent-partner’s interest
There are essentially four methods that business individuals use as a price-setting mechanism
in a buy-sell agreement:
- fixed price
- formula-determined price
- appraisal-determined price
- combination of the above mechanisms
The Uniform Standards of Professional Appraisal Practice (USPAP) contain
The Uniform Standards of Professional Appraisal Practice (USPAP) contain the rules of valuation
followed by many appraisers.
The main advantage of using a fixed price in a buy-sell agreement for a family corporation is that it pegs the value of the stock for federal estate tax purposes?
False
A fixed price is disadvantageous in a buy-sell agreement for a family corporation because the agreement will likely fail the tests to peg the value of stock accurately at fair market value. Since a fixed price does not adequately reflect fluctuations in market value, it is likely that the IRS will find the agreement to be either (1) a device to pass the stock to family for less than full consideration or (2) inconsistent with the terms of an agreement reached at arm’s length. Even if the parties are unrelated, the fixed-price provision generally provides an inaccurate result.
Most buy-sell agreements should include a first-offer or right-of-first-refusal provision?
True
In general, the first decision that must be made in developing a buy-sell agreement is establishing a price?
True
Although a buy-sell agreement can provide many benefits to owners of a business, it does not keep the business from going through probate?
False
Buy-sell agreements are transfers by contract, and therefore avoid the probate process. A properly designed buy-sell agreement will enable the business purchasers, usually the surviving co-owners, to obtain the decedent’s business interest according to the terms of the agreement and avoid the difficulties associated with probate.
Under a fully insured corporate cross-purchase agreement, the corporation acquires life insurance on the life of each shareholder who is a party to the agreement?
False
Under a fully insured corporate cross-purchase agreement, each shareholder, not the corporation, should purchase adequate life insurance on the life of the other shareholders.
Under a fully insured proprietorship buy-sell agreement, the applicant, owner, and premium payer of the life insurance on the proprietor’s life should be the purchasing employee?
True
Although life insurance is becoming more popular as a funding source for buy-sell agreements, it is still used to fund a minority of buy-sell agreements?
False
In most instances life insurance is used for funding buy-sell agreements.
