Tax planning for buy-sell agreements: taxes - Brief Article

Nation's Business, March, 1996 by Albert B. Ellentuck

Every closely held corporation with more than one stockholder should have a buy-sell agreement. Typically, such an agreement provides for the surviving owners of the corporation to buy the shares of a stockholder in the event of his death. It might also provide for the purchase of the shares of a disabled or retired stockholder.

Because there usually is no market for the stock interest of a deceased stockholder in a closely held corporation, the buy-sell agreement provides a market for those shares and liquidity for the deceased shareholder's estate.

It also provides continuity of management by requiring the estate of a deceased owner to sell the decedent's interest in the business to the corporation or to the surviving owners.

Traditionally, buy-sell agreements have been structured as corporate stock redemptions so that the corporation would be required to purchase the shares of the deceased stockholder. Under such an arrangement, the corporation would usually purchase life insurance on each stockholder to fund the purchase of each one's shares upon his or her death.

The traditional buy-sell agreement has been falling out of favor, however, because the life-insurance proceeds received by the corporation may now be subject to the alternative minimum tax (AMT) in addition to the corporations regular income-tax liability,

The AMT has its most dramatic effect when a company is losing money and has no regular tax liability. Take, for example, a corporation that is operating at a loss and receives $1 million of life-insurance proceeds upon the death of a stockholder. The corporation could be subject to an AMT of up to $138,000 even though it may have no regular income-tax liability.

The AMT also applies in instances where the company is making money, but the amount of the tax is offset by the amount the company paid in regular corporate-income taxes.

To avoid the AMT on life insurance, companies increasingly are structuring so-called cross-purchase agreements. Under a cross-purchase agreement, the remaining stockholders, not the corporation, purchase the shares of the deceased stockholder.

The mechanics of a cross-purchase agreement can be complex. If, for example, there are five shareholders, each shareholder theoretically would be required to purchase life insurance on each of the other four shareholders, thus requiring 20 policies.

As a practical matter, however, stockholders have recently turned to trusts or partnerships to hold one policy on the life of each stockholder, thus making it simpler to maintain the policies.

There are a number of other tax and nontax considerations in structuring a buy-sell agreement. So it is always advisable to consult with your tax attorney when considering such an arrangement.