Buy/Sell Agreements

Cross Purchase Buy/Sell Agreements are established directly between the owners, shareholders, or owners and key employees. Advantage This design creates a step up in basis for tax purposes for the surviving owners at the current business value for the purchased stock. It is not unusual, especially for small firms, for the business value to increase dramatically from it's inception. The taxable gain on a lifetime sale of the business could be substantial, but the taxable gain on the portion acquired through this form of agreement could be much lower due to a more current valuation and the corresponding increased cost basis. 

Disadvantage If there are more than a few owners or shareholders this design can become cumbersome, especially in funding. For example, if there are five owners, each one would buy a small life insurance policy on each of the other four, twenty policies in all (N x N - 1). Differences in age and health could also create a disparity between what each owner would pay in premiums.

This is also referred to as a Stock Redemption Agreement. In this form of agreement, the company buys the decedent's shares or business interest and the surviving owners or shareholder's interest is inflated or increased in value. Stock is redeemed or becomes treasury stock with no current value. Advantage For insurance funding purposes the number of shareholders or owners is less significant. The entity or business purchases life insurance on each owner and is the owner, premium payer, and beneficiary. In the prior example with five owners there would be only five policies necessary versus twenty. Differences in premium due to age and health would also be more manageable. Disadvantage There would be no step up in basis on the acquired business interest. Consequently, a lifetime sale of that portion would carry the full tax liability from business inception.

Wait and See designs may feature a combination of both methods where the business entity generally has first right of refusal to exercise it's option to purchase the decedent's stock or interest. Surviving owners or shareholders have a contingent right to purchase any portion of the business that is not acquired directly by the entity. The entity must then purchase any remaining shares or interest all within the allotted time stated in the document. Advantage This design allows some flexibility for unanticipated future developments in the tax code, financial condition of surviving owners and heirs, and the current financial status of the business. Disadvantage Because of the flexible nature of this design, care should be exercised in the method of funding. By considering the advantages and conditions of the other two methods, an unintended tax consequence can be avoided.