Buy-Sell Agreements Chapter 27 Tools & Techniques of Life Insurance Planning  What is it?  legal contract restricting the right to dispose of a business interest to specified parties according to specified terms  Requires the sale of business at a formula determined price upon a triggering event  Death  Disability  Retirement  Withdrawal from the business at some earlier time or  In some cases, upon the attachment of the owner’s property by creditors or in a divorce

Buy-Sell Agreements Chapter 27 Tools & Techniques of Life Insurance Planning  When is the use of such a devise indicated?  When it is essential or desirable to create a market for a business interest upon the death, long-term disability, retirement, divorce or bankruptcy of an owner  When a shareholder is unwilling or unable to continue running a business with a family of a deceased co-shareholder or someone outside the business  When the continuation of a business at an owner's death involves a high amount of financial risk, or it is desirable to covert the business into cash at that time  When a highly paid owner-employee dies  When federal or state law make it imperative that the closeness of a close corporation be maintained

Buy-Sell Agreements Chapter 27 Tools & Techniques of Life Insurance Planning  What are the requirements?  Restraints on transferability of stock must be placed in corporate charter  Stock certificates must be marketed with a “legend”  This note clearly states that the stock is subject to restrictions and specifies where those restrictions can be found  Written document between parties drawn up and properly executed  States business purpose  Refers to events that trigger a buy-out  Formula for share price  Explains how and when purchased stock is to be delivered

Buy-Sell Agreements Chapter 27 Tools & Techniques of Life Insurance Planning  What are the requirements? (cont'd)  Written document between parties drawn up and properly executed (cont'd)  Lists any restrictions on lifetime transfers  State any exemptions to the general terms  Explains how funding is arranged with specific reference to life insurance  Provides for additional purchase of life insurance if stock value increases  How funding of sales price in excess of insurance is to be made  Explains what happens in the event of  Bankruptcy  Receivership  Dissolution  Lifetime purchases or disposal at death of all the stock of a shareholder  Voluntary termination of the agreement  Applicable jurisdiction under whose laws the document is to be construed

Buy-Sell Agreements Chapter 27 Tools & Techniques of Life Insurance Planning  Tax implications  Premiums are not income-tax deductible  Death proceeds will be received income tax free regardless of who owns the policy  Life insurance proceeds received by a corporation may be subject to AMT  Income-tax free nature of insurance death proceeds may not hold if there has been a transfer for valuable consideration  Corporate premium payments are not taxed as either a constructive dividend or excess salary is the corporation is the beneficiary  No accumulated earnings tax where the cash values accumulate in policies that will be used for stock redemption

Buy-Sell Agreements Chapter 27 Tools & Techniques of Life Insurance Planning  Tax implications (cont'd)  For cross purchase plans, the cash value of the policies owned by the decedent on the lives of the surviving shareholders will be included in his or her estate  Will the formula price for the stock set forth in a buy-sell agreement fix the value of the stock for estate tax purposes  When the buyer and seller are not the natural objects of each others bounty  The estate must be obligated to sell the stock at a shareholders death  The price must be fixed by the terms of the agreement or the agreement must contain formula or method for determining the price  The price must be fair at the time the agreement is entered into

Buy-Sell Agreements Chapter 27 Tools & Techniques of Life Insurance Planning  Tax implications (cont'd)  Will the formula price for the stock set forth in a buy-sell agreement fix the value of the stock for estate tax purposes (cont'd)  When the buyer and seller are the natural objects of each others bounty  Document must represent a bona-fide business arrangement  Agreement must not be a device to transfer the stock for less than full and adequate consideration  Terms of the agreement must be viewed as an arms-length transaction  No taxable gift occurs upon the execution of a buy-sell agreement  A buy-sell agreement usually does not fix the gift tax value of the stock

Buy-Sell Agreements Chapter 27 Tools & Techniques of Life Insurance Planning  Tax implications (cont'd)  The non-exercise of a favorable purchase right under a buy-sell agreement may have gift tax implications  IRS could argue that the waiver of an option to buy stock under a buy-sell agreement is, itself, a taxable gift to the extent a holder of the right chooses not to require the same and a family member benefits by this inaction