A cross-purchase
buy-sell agreement is a written and binding agreement wherein
each business partner or shareholder individually agrees
to purchase the interest of a partner/owner if one of the
conditions that triggers the agreement occurs. Triggering
events generally include the death, disability or retirement
of a business owner or otherwise sale of a shareholder’s
interest. The agreement outlines the terms of the sale and
establishes a formula for determining the actual sales price
of the stock based on the company’s valuation. It also
obligates the remaining business owners to buy the departing
owner’s shares of the company based on each owner’s
individual percentage of interest outlined in the agreement.
As part of the agreement, the departing shareholder, or her
heirs, is also obligated to sell her interest in the company.
With a cross-purchase plan, the company is not a party to
the agreement.
 How
Does a Cross- Purchase Buy-Sell Plan Work?
Advantages
of Cross- Purchase Plans
Disadvantages
of Cross- Purchase Plans
Cross-
Purchase Buy-Sell Agreements and Taxes
How Does a Cross-Purchase Buy-Sell Plan Work?
In the article titled, What
is a Buy-Sell Agreement?, we
identified life insurance as an optimum vehicle for funding
any buy-sell
plan. Using life insurance to fund a cross-purchase plan,
each business owner purchases a policy on the life of
each of the other owners in an amount equaling their share
of
the purchase price of the insured owner’s interest.
Each business owner is the policy owner and beneficiary
of each of the policies on the lives of the other owners.
In the event an owner dies, the remaining business owner’s
receive the proceeds of the life insurance policies and
use these proceeds to purchase the deceased owner’s
business interest at a previously agreed upon price. When
a deceased owner’s interest is purchased, the surviving
owners generally receive a “step up” in the
cost basis of their business interest while the former
owner’s estate receives instant liquidity at a
fair market value for their business interest.
Advantages of Cross- Purchase Plans
A properly drafted cross-purchase
buy-sell agreement that is funded with life insurance
will have the following advantages.
1.
|
Creates a directive for a smooth business
transition in the event of an unforeseen death. |
2.
|
Creates an instant market for the business at a pre-arranged
fair market value. |
| 3. |
Remaining owner’s receive an increase or “step
up” in their cost basis equal to the price of the
shares purchased. |
4.
|
May establish a useable fair market value for the business
for estate tax purposes. |
5.
|
Policy proceeds and cash values are not accessible
by the creditors of the business. |
6.
|
There are no dividend issues with cross-purchase plans. |
7.
|
Life insurance proceeds received by the business owners
are not subject to corporate taxation nor will they increase
the alternative minimum tax liability. |
| 8. |
Provides liquidity for the deceased owner’s estate. |
Disadvantages of Cross- Purchase Plans
The disadvantages of cross-purchase buy-sell agreements include:
1.
|
Life insurance policies are not owned by
the business so any cash values cannot be considered
company assets. |
2.
|
Depending on the varying ages of the business owner’s
actual premium payments may vary greatly. |
| 3. |
Some policies may lapse if the business owner doesn’t keep up with premium
payments. |
4.
|
Requires more policies that a stock redemption plan
therefore is more difficult to administer. If more than
3 owners, the number of policies required may get excessive.
For example, if there are 5 business owners, 20 policies
will be required. |
5.
|
Policy cash values are subject to the personal creditors
of the business owner. |
Cross-Purchase Buy-Sell Agreements
and Taxes¹
Tax issues
concerning cross-purchase plans include:
|
|
Life insurance policy premiums are not
tax deductible to the business owners. |
|
|
Any death benefit proceeds received by a business owner
are received income tax free. |
|
|
If the business is properly valued, the value defined
in the buy-sell may likely be binding when calculating
the estate tax value for income and estate tax purposes. |
|
|
Once a deceased owner’s shares are purchased,
the remaining owner’s receive an increase or “step
up” in their cost basis equal to the price of the
shares purchased. |
Effective business planning using
a properly funded buy-sell agreement will guarantee that
a business has a smooth transition in the event that a business
owner dies or is disabled. The costs associated with implementing
a plan is minimal compared to the potential headaches associated
with failing to adequately plan. A cross-purchase buy-sell
agreement may be just the solution to assure that your company
is not severely impacted by an unforeseen death or disability
of a business partner.
For questions regarding cross-purchase buy-sell plans, call
MEG Financial today at (877) 583-3955. A licensed
insurance agent can personally review your circumstances
and help you
uncover potential options for your business.
Request a Life
Insurance Quote to Fund a Cross-Purchase Plan
For Additional Information on Business Continuation Planning
see:
¹ Neither MEG Financial nor any
of its licensed agents provide legal or tax advice. Please
consult
your CPA or tax
advisor for tax questions relating to your specific circumstances. |
