Funding Buy-Sell Agreements with Life Insurance

1. Buy-Sell Agreements Funded
With Life Insurance
Jay C. Lewis, CLU

2.  Why Should You Consider a Buy-Sell Agreement?
 Why Fund With Life Insurance?
 Cross Purchase Buy-Sell
 Entity Purchase Buy-Sell
 Unilateral Buy-Out
 Wait and See Buy-Sell
 Escrowed Buy-Sell
 Disability Buy-Out
 General Tax Considerations
 Tax Consequences to Seller
 Basis for Surviving Owners
 Selecting a Buy-Sell Structure
 Valuing a Business

3. Why Should You Consider a
Buy-Sell Agreement?
Buy-sell planning helps preserve control and value of a business at
the death, disability, or retirement of an owner.
These agreements provide that the estate of a deceased owner will
be paid a fair value for his/her interest, and that the surviving owners
will maintain control and ownership of the business. Life insurance on
the owners can be a source of money to fund these arrangements.

4. Why Fund With Life Insurance?
 Assure that funding is available to purchase the business
interest at the business owner’s death
 Provide funds to purchase the business interest for the
cost of premiums paid on the policy
 Avoid negative impact on working capital and credit
position of the business
 Simple and effective funding method when compared to
other methods, such as a taxable sinking fund or paying
“out-of-pocket” for the business interest

5. Cross Purchase Buy-Sell
 Owners (A and B) enter into an agreement that surviving
owner will purchase the business interest of a deceased
owner
 Each owner buys a life insurance policy on the other
owner and names self as beneficiary (i.e., A is owner and
beneficiary of policy on B’s life)

6. Cross Purchase - How Does It Work?
Business
Loan
Owner A Buy-Sell Owner B
Client
Agreement Loan
Life Insurance
Company
1. Owners enter into an agreement that surviving owner will purchase the business
interest of a deceased owner.
2. Each owner buys a life insurance policy on the other owner and names self as
beneficiary.

7. Cross Purchase - How Does It Work?
Business
Loan
Business Interest Estate of
Owner A
Client $ Owner B
Loan
$
Life Insurance
Company
3. Owner A receives the death benefit from Life Insurance Company.
4. Owner A Buys the business interest from the estate of owner B.
5. Result: Owner A owns 100% of business.

8. Cross Purchase Advantages
 Purchasers obtain an increased basis in the acquired
business interest which means potential tax savings at a
later lifetime sale
 Funding is not subject to the claims of business creditors
 Funding can be assisted by the business through
additional compensation
 If the business has a higher tax bracket than the
individuals there is greater tax leverage by having the
individuals pay the premiums
 Allows owners to designate percentage of ownership
acquired

9. Cross Purchase Disadvantages
 Plan may be difficult to administer if there are multiple
owners
 There is less tax leverage if the business has a lower tax
bracket than the individuals
 Insured plans require multiple policies on each owner. No.
of policies needed = No. of Owners x (No. of Owners - 1)
 Perceived inequity if large differences in premiums due to
age/health

10. Entity Purchase Buy-Sell
 Business and owners (A and B) enter into an agreement
that the business will purchase the interest of a deceased
owner
 Business buys life insurance policies on each owner and
names business as beneficiary

11. Entity Purchase - How Does It Work?
Loan
Buy-Sell Owner B
Business Agreement
Loan
Life Insurance
Company Owner A
Client
1. Business and owners enter into an agreement that the business will purchase the
interest of a deceased owner.
2. Business buys life insurance policies on each owner and names business as
beneficiary.

12. Entity Purchase - How Does It Work?
Loan
Business Interest Estate of
Business $ Owner B
Loan
$
Life Insurance
Company Owner A
Client
3. Business receives the death benefit.
4. Business buys the business interest from the estate of owner B.
5. Result: Owner A owns 100% of business.

13. Entity Purchase Advantages
 Funding is provided by the business rather than by the
individual owners
 Requires only one insurance policy on each owner
 There is greater tax leverage if business has a lower tax
bracket than the individuals
 Discrepancies in premiums due to age/health are less of a
perceived problem

14. Entity Purchase Disadvantages
 Possible problem with the corporate accumulated earnings
tax
 Stock attribution rules could cause payment from the
business to the estate to be taxable as a dividend
 Funding is subject to the claims of business creditors
 No new cost basis for surviving owners if business is a C
corporation
 Does not allow owners to designate percentage of
ownership acquired — may result in unintended shift of
control
 There is less tax leverage if business has a higher tax
bracket than the individuals
 Corporate cash values and death benefit may be subject to
alternative minimum tax

15. Unilateral Buy-Out
 A sole proprietor and key person enter into a buy-sell
agreement
 Key person buys a life insurance policy insuring the sole
proprietor
 At the death of sole proprietor, key person receives the
death benefit and buys business from sole proprietor’s
estate

16. Wait and See Buy-Sell
 The business has option to buy all or a portion of a
deceased owner’s interest
 The surviving owners have option to buy any of the
ownership interest not purchased by the business. Any
interest not purchased by the remaining owners must then
be purchased by the business
 Insurance policies to fund the wait and see plan can be
maintained by either the owners or the business. Normally
the funding is maintained by the owners. If the business
decides to purchase the decedent’s interest, the surviving
owners lend or contribute the funds to the business

17. Escrowed Buy-Sell
 A cross purchase buy-sell plan which requires only one
policy per owner
 An escrow agent holds the business interests and
insurance policies of each owner
 Premiums are paid by the owners
 Sometimes referred to as the Trusteed Buy-Sell plan

18. Disability Buy-Out
 Provisions are included in any type of buy-sell agreement
for purchase of business interest from owner who
becomes disabled
 Disability buyout insurance is purchased to fund buyout

19. General Tax Considerations
 Premium payments are not deductible
 Proceeds paid on death are generally received free of
income tax
 The value of the business interest for estate tax purposes
will generally be measured by the value specified in the
buy-sell agreement, although the IRS is not bound by
values specified in agreements between family members
 Termination of funded cross purchase buy-sell plan may
trigger taxable income if policies with gain are exchanged
 Unless an exception is available, the transfer for value rule
could cause the death benefit to be income taxable if a
policy is transferred to a shareholder who is not the
insured

20. Tax Consequences to Seller
 On the sale of a business interest by a deceased owner’s
estate, the estate generally recognizes no gain because its
basis is “stepped up” to fair market value at death
 A portion of the payment to the estate may be taxed as
ordinary income if the business is a partnership with
accounts receivable, appreciated inventory, or goodwill
 Stock attribution rules may cause the payment to the
estate from a family owned corporation to be taxed as a
dividend

21. Basis of Surviving Owners
 In a cross purchase buy-sell, a purchasing owner’s basis in
the business interest is increased by the purchase price
 In an entity buy-sell, the basis of the surviving owners might
be increased when the death benefit is paid, depending on
the type of entity:
◦ C Corporation: Stock basis of remaining shareholders is
not increased
◦ S Corporation: Each owner’s basis is increased
proportionately by insurance proceeds received by the
entity. A 1377 election may be made in a cash basis S
corporation to allocate all basis increase to surviving
owners
◦ Partnership: Life insurance proceeds received by the
partnership increase each partner’s basis proportionately
unless special allocations are made
◦ LLC: Generally same as partnership

22. Selecting a Buy-Sell Structure
 Who should be the purchaser?
 How many owners exist?
 How old are the owners?
 What percentage of ownership does each owner have?
 What is the type of business entity?
 Are the owners related?
 Are the owners insurable?
 What is the net worth of each owner?
 What are the tax brackets of the owners and business entity?
 Do non-active spouses have any interest in the business?
 Do other family members have an interest in the business?
 Who should pay for premiums on insurance policies?
 What is the likelihood the business will be sold during the
owner’s lifetimes?
 Will the surviving owners purchase the business interest pro-
rata?
 Will there be a shift in control upon an owner’s departure?
 Are there significant business or personal creditors?
 Is the business a corporation subject to alternative minimum
tax?
 Should the agreement cover death, disability and retirement?
 What is the value of the business?

23. Valuing a Business
 Valuation of a business is a critical part of a buy-sell plan
and may be based on any of the following methods:
◦ Appraisal
◦ Owner’s Agreement
◦ Adjusted Book Value
◦ Capitalization of Income
 The agreement and funding arrangement should be
reviewed periodically to determine if the valuation and
funding are current

24. Questions?
Jay C. Lewis, CLU®
IPS Advisors, Inc.
8080 N. Central Expwy., Suite 1500
Dallas, TX 75206
Office: 214-292-4117
Email: jlewis@ipsadvisors.com
Twitter: @Ins_Counselor
Blog: www.jayclewis.wordpress.com

25. Disclosures
This material was created to provide accurate and reliable information on the subjects covered but should not be regarded as
a complete analysis of these subjects. It is not intended to provide specific legal, tax or other professional advice. The services
of an appropriate professional should be sought regarding your individual situation. Neither NFP nor its subsidiaries or
affiliates offer tax or legal advice.
Any guarantees offered by life insurance products are subject to the claims-paying ability of the issuing insurance company.
Riders may be available for an additional cost. There are considerable issues that need to be considered before replacing life
insurance such as, but not limited to; commissions, fees, expenses, surrender charges, premiums, and new contestability
period. There may also be unfavorable tax consequences caused by surrendering an existing policy, such as a potential tax on
outstanding policy loans. Please discuss your situation with your financial advisor.
Securities and Investment Advisory Services may be offered through NFP Securities, Inc., Member FINRA/SIPC.
NFP Securities, Inc. is a subsidiary of NFP (National Financial Partners Corp.).