Planning for Closely Held Business Owners - 6 Types of Buy-Sell Agreements

Question 1

What are buy-sell agreements?

Answer 1

Buy-sell agreements are limits placed on ownership rights of closely-held organizations which require the shares be resold to either the organization or current partners when the owner decides to leave or passes away.

Question 2

What are the types of buy-sell agreements?

Answer 2

1) The entity-purchase agreement/stock redemption.
2) Cross-purchase agreement.
3) The wait-and-see agreement/hybrid.

Question 3

What are the objectives of buy-sell agreements?

Answer 3

*For the entity
* For the deceased owner’s estate
* For the retired or disabled owner
* For the remaining owners

• typically provide for the disposition of stock after a shareholder dies, becomes disabled, retires, is fired, or has a falling out with the other shareholders

-provide that the other shareholders will
purchase the stock upon the occurrence of the triggering event, or that the corporation will redeem the stock.

Question 4

What are the different triggering events for a buy-sell purchase?

Answer 4

death
retirement or disability of an owner
an attempted sale to a third party
the termination of employment of an owner for reasons other than death
retirement or disability
Divorce
bankruptcy or insolvency of an owner may

Question 5

What does the general rule of IRC Section 2703 state for buy-sell agreements?

Answer 5

It states that for estate, gift and generation-skipping transfer tax purposes, the value of any
property is determined without regard to any right or restriction relating to the property

Question 6

What does the general rule of IRC Section 2703 state?

Answer 6

The general rule of IRC Section 2703 is that
for estate, gift and generation-skipping
transfer tax purposes, the value of any
property is determined without regard to
any right or restriction relating to the
property

Question 7

What are the restrictions for buy-sell agreements?

Answer 7

• Agreement usually should contain restrictions on voluntary transfers of interests in the business
• Transfers may be permitted to the owner’s spouse or children, or to trusts created for their benefit, in
  order to allow the owners to engage in estate planning transactions
• Transfers to third parties may be permitted after first
  offering the interest to the entity or the other owners

Question 8

What is an entity purchase/stock redemption agreement?

Answer 8

An entity-purchase agreement is a buy-sell agreement between the business itself and the owners of the business. Upon a triggering event (e.g., an owner’s death, disability, termination of employment), the business agrees to purchase the interest of the departing owner at an agreed-upon price.

Question 9

What is a cross-purchase agreement?

Answer 9

A cross-purchase agreement is a document that allows a company’s partners or other shareholders to purchase the interest or shares of a partner who dies, becomes incapacitated or retires. The mechanism often relies on a life insurance policy in the event of a death to facilitate that exchange of value.

Question 10

What is a wait- and - see agreement/hybrid?

Answer 10

A “wait and see” buy-sell agreement is a legal document drafted by an attorney that controls the sale of a business interest upon various triggering events (e.g., disability, death, etc.). In a cross- purchase buy-sell agreement, the remaining owners have the obligation to buy a departing owner’s interest.

Question 11

Under a cross purchase agreement funded by life insurance policies how are the death benefits taxed?

Answer 11

Income tax free to the beneficiary

Question 12

Who owns the life insurance policy under cross purchase agreement?

Answer 12

Business Owner/Shareholder

Question 13

Who is the beneficiaries under cross purchase agreement?

Answer 13

Business Owner/Shareholder

Question 14

How do you calculate the number of policies of funds for cross purchase agreements?

Answer 14

N(N-1) where N is the number of shareholders

Question 15

What should you consider when choosing the right type of agreement?

Answer 15

-Number of owners
-Premium payments on life insurance policies
-Transfer for value problems
-Alternative minimum tax problems
-Accumulated earnings tax
-Basis for income tax purposes

Question 16

Should the Buy-Sell be Mandatory or
Optional?

Answer 16

A decision should be made on whether the
purchase or sale will be mandatory, or
whether the entity or remaining owners will only have an option or right of first refusal

Question 17

Should you consider having a different purchase price for different
events?

Answer 17

Yes, the IRS is very likely to reject a buy-sell agreement based on book value

Question 18

What are the exceptions to the buy-sell agreement?

Answer 18

• The right or restriction is a bona fide business arrangement
• The right or restriction is not a device to transfer the property to
  members of the decedent’s family or to objects of the transferor’s bounty for less than full and adequate consideration in money or money’s worth
• The terms of the right or restriction are comparable to similar
  arrangements entered into by persons in an arms’-length transaction at the time the right or restriction is created

Question 19

What are the requirements that have to be met in order for there to be an exception to the general rule of IRC Section 2703?

Answer 19

• The right or restriction is a bona fide business arrangement
• The right or restriction is not a device to transfer the property to
  members of the decedent’s family or to objects of the transferor’s
  bounty for less than full and adequate consideration in money or
  money’s worth
• The terms of the right or restriction are comparable to similar
  arrangements entered into by persons in an arms’-length transaction
  at the time the right or restriction is created

Question 20

True or False: Transfers may be permitted to the owner’s spouse or
children, or to trusts created for their benefit, in order to allow the owners to engage in estate planning transactions

Answer 20

True

Question 21

True or False: Transfers to third parties are not permitted in a buy-sell agreement

Answer 21

False: Transfers to third parties may be permitted after first offering the interest to the entity or the other owners

Question 22

Is there a possibility of AMT affecting a C corp? (true or false)

Answer 22

True

Question 23

What is a stock redemption plan?

Answer 23

-the company purchases life insurance on the shareholder’s life
-The insurance will provide the company with the necessary funds to purchase (redeem) the stock of the withdrawing or deceased shareholder, at a future time.

Question 24

In a stock redemption plan, assuming the corporation is sole owner and sole beneficiary of the policy, the value of the insurance on the decedent’s life will OR will not be includable in his gross estate?

Answer 24

Will not

Question 25

Who is the owner and beneficiary of a stock redemption plan?

Answer 25

The corporation is the owner and beneficiary of the policy and pays all of the insurance premiums.

Question 26

What is the Generation-Skipping Transfer Tax?

Answer 26

It is a federal tax that results when there is a transfer of property by gift or inheritance to a beneficiary (other than a spouse) who is at least 37½ years younger than the donor

Question 27

What is the Generation-Skipping Transfer Tax Exemption?

Answer 27

This exemption is an amount that can be directly transferred to grandchildren or into a generation-skipping trust for the benefit of grandchildren without incurring a federal GST

2022: $12,060,000
2023: $12,920,000 (Jan 1, 2023)

Question 28

What is a Dynasty Trust?

Answer 28

A Dynasty Trust provides for life estates in property for every generation of beneficiaries. It is typically structured to last for the
maximum period of time permitted by state law for a trust to last and offers the additional attraction
of asset protection for future generations.