Is Buy Sell Insurance Tax Deductibleadmin
A purchase-sale contract is a legally binding agreement between the co-owners of a company. Sometimes we talk about a buyback agreement. A version of this article was originally published in the September 2019 issue of Thomson Reuters` Estate Planning magazine. Buy-sell agreements are crucial when it comes to a close-knit business, and yet they are often ignored or overlooked by business owners. Life insurance is an effective tool that allows entrepreneurs to implement the terms of a purchase-sale contract by providing cash to their business and family upon the death of an owner. A well-designed buy-sell contract is essential to avoid conflicts and remember how life insurance proceeds should be used in the event of the death of a business owner. The creation of a separate life insurance storage unit is increasingly being used by practitioners in the planning of purchase-sale agreements to avoid tax and other pitfalls. What is a purchase and sale contract? More generally, a purchase and sale agreement (which may form part of a shareholders` agreement, operating agreement, partnership agreement or any other arrangement) is an agreement between the owners of a narrowly held company that restricts the rights of owners to transfer their shares in the company. It also usually gives other owners and the company in a combination the right (and sometimes the obligation) to acquire an owner`s interest if the owner dies or wants to make a lifetime transfer of his interests. Therefore, a properly drafted purchase and sale agreement can prevent the transfer of interests from a deceased business owner to third parties in which the remaining owners do not wish to have shares in the business, and it can also provide liquidity for the estate of a deceased owner.
The triggering events of a purchase-sale contract can extend beyond death and voluntary lifetime transfers. A possible involuntary transfer, as it could result from divorce or bankruptcy, can also trigger purchase rights or obligations. Other events may include the permanent disability of the owner or the termination of an owner`s employment relationship with the business. The purchase and sale agreement specifies how the value of a transfering owner`s shares is to be determined. In some situations, the purchase-sale agreement can only provide for an assessment of interest at the relevant time. In other cases, an evaluation formula may be defined. In the latter case, it is particularly important that the purchase and sale agreement be regularly reviewed to ensure that the formula continues to generate reasonable value for the company`s shares.  Use of life insurance to finance a purchase-sale contract A purchase-sale contract does not require the validity of a financing mechanism. The Company and its owners may have sufficient resources to pay for all shares that may be acquired under the terms of the Agreement. However, it is very common to finance interest purchase obligations upon the death of homeowners with life insurance.  The proceeds of life insurance are used to purchase the deceased owner`s interest, or at least as much as can be covered by the insurance.
This can reduce the financial burden on the business and the remaining owners. As explained directly below, the use of life insurance can make it difficult to buy and sell depending on the structure of the agreement. However, these complications can usually be managed, and the benefit of having the life insurance product available to buy the interest usually outweighs the potential drawbacks. Buyback or cross-purchase contract? A purchase-sale agreement can be structured by the surviving owners as a buy-back agreement or as a cross-purchase agreement. In some cases, the deal could be a hybrid of the two. In addition, a limited liability insurance company, discussed later in this article, can also be used to maximize creditor protection and other tax benefits. Example. Three people, A, B and C, form a company and are the first sole shareholders. What factors should they consider when structuring their buy-sell agreement? In a repurchase agreement, upon the death of an owner, the company is the buyer (or at least the principal buyer) of the deceased`s shares in the company. Therefore, the company will own the life insurance policies that insure the lives of its owners. Upon the death of an owner, the proceeds are paid to the corporation and the corporation uses the proceeds to purchase the deceased owner`s interests from his or her personal representative.
Once the company buys the shares, the shares are no longer outstanding and the shares of the remaining owners of the company are increased proportionately. Redemption is simple and offers centralized management to manage policies and collect death benefits. Because the policies are owned by the business, they are not subject to the reach of the owner`s creditors or can`t be included in the owner`s estate. If an owner leaves the business, the policies of the other owners would not be disrupted as they would with a cross-purchase agreement. With a cross-purchase agreement, the surviving business owners (not the corporation) acquire the deceased owner`s shares in the corporation (or at least have the first call option). Business owners individually own the policies that ensure everyone`s life. When a business owner dies, the proceeds are paid to the surviving owners who hold one or more policies for the deceased owner, and those surviving owners purchase the shares of the deceased owner`s personal representative. All shares that surviving owners buy from the deceased owner have a basis equal to what the surviving owners paid for the shares. If these shares are then sold for more than their base, the surviving owners will receive a lower capital gains tax than the other shares they hold. Note that the stock base of S Corporation or an interest in a partnership fluctuates from year to year depending on the company`s activities and distributions. A cross-purchase agreement can also avoid restrictions imposed by lenders or creditors on a company`s cash flow, as sales of ownership shares take place between owners without involving the company.
The owner of insurance policies must be the first buyer, i.e. “track the money”. In a buy-back agreement, the company owns and pays for all life insurance policies and is also a beneficiary of the policies. In the example above, when A dies, the proceeds of the life insurance policy are paid directly to the company, which then uses the funds to redeem the shares held by A.B`s personal representative and C would not be directly involved in the purchase. In a cross-purchase agreement, A, B, and C own each other`s policies, and they each name the others as beneficiaries. Thus, if A dies, B and C would receive the proceeds directly from the policy and would individually purchase A`s shares from A`s personal representative. The company would not be involved. Note that the number of policies required under a cross-purchase agreement is higher than that of a buyback agreement if more than two owners are involved. .