Alternate Buy Sell Arrangements

 

Cross Endorsement Buy Sell Arrangement

In a cross endorsement buy sell arrangement, each business owner will purchase and own a life insurance policy on his or her life. The value of each policy will be based on the projected value of the business and each business owner’s proportional interest in the business.12 The arrangement is structured as an endorsement split-dollar plan so that a portion or all of the death benefit can be endorsed for a “rental charge” to the other business owners13 to satisfy the obligation under the buy-sell agreement.

Each business owner will recognize rental income on what they charge on their policy. To minimize the cash outlay needed to pay premiums, the company may make annual bonus payments to each business owner in the amount of the premium. Each business owner, as owner of his or her own policy, will continue to have access to the policy’s potential cash values.

One Way Buy Sell Arrangement

A one way buy sell arrangement is a type of a buy-sell arrangement in which a valued employee, who may be a family member or a key person in the business, will purchase and own a life insurance policy on the life of the business owner. In this situation, because there is generally only one business owner and one designated successor, only one life insurance policy is required to fund the arrangement. The valued employee, who may be a family member or a colleague, will also be the beneficiary of the life insurance policy. The company will pay a bonus to the successor/policy owner in the amount of the premium payments annually to minimize the out-of pocket expense of the arrangement. The bonus payments may be tax-deductible to the corporation when they are paid, but the payment will also be taxable to the recipient.

No Sell Buy Sell Arrangement

A no-sell buy-sell agreement is similar to other buy-sell agreements in that management and/or voting interest will pass to the surviving owners. It is dissimilar in that the nonvoting interest in the company will remain with the deceased owner’s family or estate. A no-sell buy-sell agreement can be a good choice if the owners want the deceased owner’s heirs to benefit from appreciation in the company’s value over time and from the equalization of benefits between the first and last owners to die. A no-sell buy-sell agreement is particularly attractive in situations where substantial future appreciation is expected, for example, a dairy farm that is close to city limits and will be incorporated into the city within a few years.

The essence of a no-sell buy-sell agreement is to have each owner’s interest divided into a voting (management) interest and a nonvoting (nonmanagement) interest. For example, a partnership interest can be divided into a general partnership interest and a limited partnership interest. In a corporation (including S-corporations), the owner’s interest can be divided into voting and nonvoting shares. In the case of a limited liability company, the owner’s interest can be divided into a management interest and a nonmanagement interest. The owner’s management or voting interest is subject to a normal buy-sell agreement and so will pass to the surviving owners at the deceased owner’s death. The remaining (nonmanagement) interest will remain with the deceased owner’s family. Each owner sets up an Irrevocable Life Insurance Trust (ILIT) with life insurance in the amount of the value of his or her business interest. At the owner’s death, the life insurance in the trust will be used to support the family.

Irrevocable Life Insurance Trust (ILIT ) Buy Sell Arrangement

Business owners having a large net worth may need to be careful about how they structure their buy-sell arrangements. If their taxable estate (which includes the fair market value of their business interests) puts them in jeopardy of paying federal estate taxes and/or state estate taxes, it may not make financial sense for them to personally purchase the interest of another owner who leaves the business. Doing so could potentially increase their federal or state estate tax liability. An alternative approach may be preferable.

Instead of personally purchasing a departing owner’s interest, an owner could establish an irrevocable life insurance trust (ILIT) to purchase it. The ILIT would have provisions favorable to the grantor-business owner and the instructions to the ILIT trustee would be drafted to suit the grantor-owner’s objectives without causing the ILIT’s assets (including the purchased business interest) to be part of his taxable estate. Through the terms of the trust and the choice of the trustee, the business owner may possibly have some indirect influence over the purchased interest.

Next Steps

Designing a business continuation plan is a crucial step to ensure your business remains intact at your retirement, death or other triggering event. Whether you leave your business by choice or by chance, you’ll leave your business on track and help provide for your family’s future. With an entity purchase (stock redemption) arrangement, you can help protect yourself, your business, co-owners and your family.

Talk to learn more contact an HNW Life Insurance Professional at (877) 579-9574 or submit an online request to schedule a time to discuss your particular situation.