Buy-Sell Agreement Funded with Life Insurance – Cross Purchase Plan

Written by KPI

This is an actual example of a business succession planning case using a  cross purchase buy-sell agreement that we helped to implement and fund. The names have been changed to protect the privacy of the actual company and its owners.

Cross Purchase Buy-Sell AgreementThe business owners of ABC, Inc., an international trading company in Miami, FL contacted our office with questions regarding how to fund their buy-sell agreement that they were drafting with their attorney.  The company is equally owned by two individuals, Jose age 50 and Henry age 46 and both are in excellent health which made a cross-purchase buy-sell agreement an ideal solution.

What is a Cross Purchase Buy-Sell Agreement?

buy-sell agreement is a very important legal document for businesses that establishes the ground rules for disposition of the business in the event that things such as death or disability or early retirement come into play.

At the time of our discussions, ABC, Inc., had been in business for 10+ years and had consistently  strong revenue and very good earnings.  Based on its historical performance and future expectations, the company was appraised at a fair market value of $4M.

The goal was to protect the spouses of the owners in the event that one of the principals dies unexpectedly and to assure that the surviving owner retains 100% of the company.

After many questions regarding company structure, goals and objectives of each owner as well as health and lifestyle issues. We looked at two possible solutions for ABC, Inc.

So, we looked at a couple of different strategies for the buy-sell agreement: the Entity Plan, also referred to as a Stockholder Redemption Plan and a Cross Purchase Plan.

The entity plan would allow for the business to purchase and own life insurance policies on the lives of both Jose and Henry in an amount equal to their equity ownership interest, $2,000,000 each in this case. The business would be the beneficiary and receive the proceeds at the death of either Jose or Henry. At that point, the business would then redeem the shares of the deceased members estate and the surviving owner would then retain 100% ownership in ABC, Inc.

The cross-purchase buy-sell agreement strategy would work differently in that the owners, Jose and Henry, would own $2,000,000 life insurance policies on each other, pay the premiums out of their own pockets and be the beneficiaries of each others’ policy. At the death of either Henry or Jose, the survivor would receive the policy proceeds directly and then buy-out the deceased owner’s estate as per the buy-sell agreement terms. The survivor would then own 100% of the business.

After careful consideration, Jose and Henry determined that the cross-purchase buy-sell agreement was the best alternative. So, Jose purchased a term life insurance policy in the amount of $2,000,000 on the Henry’s life and pays the premiums and is the beneficiary. Likewise, Henry purchased a $2,000,000  life insurance policy on Jose with himself owing the policy, paying the premiums and being the beneficiary.

Tax Advantage of Cross Purchase Buy-Out AgreementThe chief reason we went with the cross-purchase buy-sell agreement plan, was the tax advantages for Jose and Henry. With each owning and paying the premium payments and being the policy beneficiary on a life insurance policy on the other owner, in the even that either Jose or Henry passed away, the survivor would received the policy proceeds tax free. Subsequently, the survivor could individually redeem the equity ownership of the deceased owner. In this case, the surviving owner would receive an automatic step-up in cost basis of $2,000,000. So in the event, the surviving owner decided to sell the company in the future, he would pay no taxes on this $2,000,000 as he has already paid this amount for the fair market value to the deceased owner’s estate.

If your company is working on business succession planning and is drafting or reviewing a buy-sell agreement, you need to carefully consider your options. In this particular case, a cross purchase buy-sell agreement was the best alternative. However, each company has its own specific goals and objectives that are likely significantly different that ABC, Inc. Consulting with a qualified attorney, tax advisor and independent insurance agent is critical to reaching your desired objectives.


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