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Buy Sell2010

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Considers several options business owners face when planning for the continuation of the business in the event of death or disability.

Considers several options business owners face when planning for the continuation of the business in the event of death or disability.


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  • 1. Buy-Sell Planning © 2010 VSA, LP Valid only if used prior to January 1, 2011. The information, general principles and conclusions presented in this report are subject to local, state and federal laws and regulations, court cases and any revisions of same. While every care has been taken in the preparation of this report, neither VSA, L.P. nor The National Underwriter is engaged in providing legal, accounting, financial or other professional services. This report should not be used as a substitute for the professional advice of an attorney, accountant, or other qualified professional.
  • 2. What Happens When a Business Owner Dies? The type of business organization determines the impact on the business of the death of an owner. Sole Proprietorships
    • Since a sole proprietorship has no legal identity apart from its owner, the death of a sole proprietor terminates the business .
    • All business assets and liabilities become part of the sole proprietor’s personal estate and it then becomes the responsibility of the executor or administrator to settle the estate, including disposition of the sole proprietorship.
    • Without proper advance planning, the only solution may be a financially-disastrous forced liquidation of the sole proprietorship in order to pay debts and estate settlement costs, with the heirs receiving the remainder of the liquidation value, if any.
  • 3. What Happens When a Business Owner Dies? The type of business organization determines the impact on the business of the death of an owner. Partnerships
    • In the absence of an agreement to the contrary, the partnership is dissolved at the death of a partner . The surviving partners have no authority to act for the partnership, except for purposes of winding up its business affairs.
    • When a partner dies and there is no plan to dispose of the business interest, the only options available to the survivors are reorganization or liquidation of the partnership.
    • Both the surviving partners and the deceased partner’s heirs must consent to a reorganization of the partnership.
    • If an attempt to reorganize fails, as it frequently does without advance planning, the only other alternative is to liquidate the partnership and distribute the proceeds to the surviving partners and the heirs.
  • 4. What Happens When a Business Owner Dies?
    • The death of a shareholder in a closely-held corporation has no legal effect on the life of the business. The deceased shareholder's interest in the corporation may pass to the shareholder's heirs or beneficiaries. The corporation itself may still be legally intact and able to carry on its business affairs.
    • However, while the death of a shareholder may have no legal effect on a closely-held corporation, there are some very real practical consequences that can have a serious impact. Not only has an important member of the management team been lost, but there is also the issue of the shareholder’s heirs, who now own an interest in the business.
    The type of business organization determines the impact on the business of the death of an owner. Closely-Held Corporations
  • 5. Practical Consequences at the Death of a Partner or Shareholder: The heirs of a deceased partner or closely-held corporate shareholder now own an interest in the business. In the absence of advance planning, the heirs: Is one or more of the heirs qualified and willing to assume an active role in managing the business? Do the surviving owners want to be in business with the deceased owner’s family? Can Become Active in the Business
  • 6. Practical Consequences at the Death of a Partner or Shareholder: The heirs of a deceased partner or closely-held corporate shareholder now own an interest in the business. In the absence of advance planning, the heirs: Will the heirs and the surviving owners be able to agree on a price? How will the surviving owners fund the purchase? Will the heirs sell to outsiders, leaving the surviving owners to work with a new owner selected by the deceased owner’s family? Can Sell Their Business Interest Will the surviving owners be willing and able to support the deceased owner’s family, as well as their own? Will the interests of the surviving owners and the heirs in running the business be compatible? Can Remain Inactive
  • 7. Problems Faced by the Heirs: When a business owner dies, the heirs may be faced with a number of problems, including: Will there be a ready market for a small business? Market Will there be sufficient liquidity in the deceased owner’s estate to pay estate taxes and other administrative costs without selling the business interest, which may make up the majority of the estate? Estate Liquidity The heirs may need income from the business. Will this need for income conflict with the surviving owners’ salary expectations and desire to reinvest in the business? Need for Income
  • 8. There is, however, another alternative… Problems Faced by the Heirs: In many small businesses, the most sensible course of action is for the surviving owners to buy the deceased owner’s partnership interest or stock from the heirs. While the surviving owners are the ideal market for the business interest, additional problems can arise in the absence of advance planning:   Will the heirs and surviving owners be able to agree on a price?   How will the surviving owners fund the purchase?   Without advance planning, the surviving owners may find themselves in business with outside buyers, or in a bidding competition with outsiders who want to acquire an interest in a successful, established business.
  • 9. A Potential Solution Using Life Insurance: In many partnerships and closely-held corporations , an answer to the problems arising at the death of an owner may be for the surviving owners to acquire the deceased owner’s interest in the business for its fair market value.   When business owners enter into a binding buy-sell plan that is funded with life insurance, the surviving owners will have the cash to purchase a deceased owner’s interest for a previously agreed-upon price that is fair to the heirs. In the case of a sole proprietorship , if a potential purchaser exists, an insured buy-sell plan can provide for an orderly transfer of business ownership at the sole proprietor’s death.
  • 10. A Potential Solution Using Life Insurance: With advance planning an insured buy-sell plan can accomplish the following:
    • The surviving owners avoid the business problems associated with active or inactive heirs, while the heirs receive cash instead of the generally poor investment potential of a small business interest.
    • The surviving owners are committed to buy and the deceased owner’s estate is committed to sell the business interest for a price that is agreed upon in advance.
    • The funds to complete the sale are available exactly when needed at an owner’s death.
    • The value of the business interest may be fixed for federal estate tax purposes.
    • The deceased owner’s heirs are guaranteed a full and fair cash price for the business.
    • Cash becomes available to settle the deceased owner’s estate promptly and to replace family income.
  • 11. How Can a Buy-Sell Plan Be Funded? There are FOUR ways business owners can fund a buy-sell plan: Installment Method The purchase price could be paid in installments after an owner’s death. For the surviving owners, this could mean a drain on business income for years. In addition, payments to the surviving family would be dependent on future business performance after the owner’s death. 2. Cash Method The owners could personally accumulate sufficient cash to buy the stock at an owner’s death. Unfortunately, it could take many years to save the necessary funds, while the full amount may be needed in just a few months or years. 1.
  • 12. How Can a Buy-Sell Plan Be Funded? There are FOUR ways business owners can fund a buy-sell plan: Insured Method Only life insurance can guarantee that the cash needed to complete the sale will be available exactly when needed , assuming that the business has been accurately valued (guarantee is based on continued claims-paying ability of the insurer). 4. Loan Method Assuming that the surviving owners could obtain a business loan, borrowing the purchase price requires that future business income be used to repay the loan PLUS interest. 3.
  • 13. The Mechanics of an Insured Buy-Sell Plan: The bottom line is that a buy-sell plan funded with life insurance is an economical and efficient method of providing the cash necessary to purchase a deceased owner’s business interest. There are two types of buy-sell plans: Here’s how an insured cross purchase buy-sell plan could work for your business today …
    • Cross Purchase Buy-Sell Plans
    • Entity Purchase Buy-Sell Plans
  • 14. Owner B Insurance Company Mechanics of an Insured Cross Purchase Buy-Sell Plan Today : 2 Life Insurance Premiums 1 Cross Purchase Buy-Sell Agreement
    • The owners enter into a cross purchase buy-sell agreement under which they agree to buy a deceased owner’s interest and the deceased o w n e r ’ s executor is directed to sell that interest to the surviving owners for an agreed-upon price. The business itself is not part of the agreement.
    • Each business owner owns, is the beneficiary of and pays the nondeductible premiums for life insurance on the other owner(s) in an amount approximately equal to that owner’s portion of the purchase price.
    Owner A Life Insurance Policy on Owner B Life Insurance Premiums Life Insurance Policy on Owner A
  • 15. Owner B 3 Income Tax-Free Death Benefit 4 Ownership Interest 5 Settled and Distributed to
    • At an owner’s death, each surviving owner receives the income tax-free death benefit from the life insurance policy owned on the deceased owner.
    • The surviving owner(s) then use the proceeds of the life insurance to buy the business interest from the deceased owner’s estate for the purchase price agreed-upon in the buy-sell agreement.
    • After settling the estate, the executor distributes the balance of the estate to the deceased owner’s heirs.
    Owner A’s Estate Owner A’s Heirs Purchase Price Insurance Company Mechanics of an Insured Cross Purchase Buy-Sell Plan at Owner A’s Death :
  • 16. Owners Insurance Company Mechanics of an Insured Entity Purchase Buy-Sell Plan Today : 2 Life Insurance Premiums 1 Entity Purchase Buy-Sell Agreement
    • The business and its owners enter into an entity purchase buy-sell agreement under which the business agrees to buy a deceased partner’s or shareholder’s business interest and the deceased partner’s or s h a r e h o l d e r ’ s executor is directed to sell that business interest to the partnership or corporation for an agreed-upon price.
    • The partnership or corporation owns, is the beneficiary of and pays the nondeductible premiums for insurance on each owner’s life in an amount approximately equal to each owner’s interest in the business.
    Business Life Insurance Policies on Owners
  • 17. Business 3 Income Tax-Free Death Benefit 4 Ownership Interest 5 Settled and Distributed to
    • At an owner’s death, the partnership or corporation receives the income tax-free death benefit from the life insurance policy it owns on the deceased partner or shareholder.
    • The partnership or corporation uses the proceeds of the life insurance to buy the business interest from the deceased owner’s estate for the purchase price agreed-upon in the buy-sell agreement.
    • After settling the estate, the executor distributes the balance of the estate to the deceased owner’s heirs.
    Owner A’s Estate Owner A’s Heirs Purchase Price Insurance Company Mechanics of an Insured Entity Purchase Buy-Sell Plan at Owner A’s Death :
  • 18. Insured Buy-Sell Plans Comparison: At an owner’s death, the business agrees to buy and each owner agrees to sell the business interest at a predetermined price. The business interest is then “retired,” having the effect of increasing each owner’s percentage of ownership. Purchase of the business interest at an owner’s disability or retirement can also be made part of the buy-sell agreement. Depending on the number of owners, each owner agrees to buy all or part of a deceased owner’s business interest, and each owner agrees to sell at a predetermined price. The deceased owner’s business interest is thus split among the surviving owners. Purchase of the business interest at an owner’s disability or retirement can also be made part of the buy-sell agreement. Description Entity Purchase Cross Purchase
  • 19. Insured Buy-Sell Plans Comparison: The business pays the nondeductible premiums for all policies, which has the general effect of leveling premium payments among owners according to their ownership interest. Each owner pays the nondeductible premiums for the policy(ies) he/she purchases on the other owners. Premium Payments The business purchases one policy on the life of each owner in an amount equal to the value of that owner’s business interest. The total number of policies needed is equal to the number of owners. Each owner purchases a life insurance policy on each of the other owners in an amount equal to the purchasing owner’s share of the purchase price. The total number of policies needed it equal to: N x (N-1), with N = number of owners. Number of Life Insurance Policies Entity Purchase Cross Purchase
  • 20. Insured Buy-Sell Plans Comparison: Death benefits are generally received income tax free by the business but may, in the case of a corporation, be subject to the corporate alternative minimum tax. When policy ownership is properly arranged, the death benefits will not be included in the deceased owner’s estate. Death benefits are generally received income tax free by the surviving owners. When policy ownership is properly arranged, the death benefits will not be included in the deceased owner’s estate. Taxation of Death Benefits The business should be the owner and beneficiary of the life insurance policies. Each business owner should be the owner and beneficiary of the policy(ies) he/she purchases on the other owner(s). Policy Owner and Beneficiary Entity Purchase Cross Purchase
  • 21. Insured Buy-Sell Plans Comparison: Does not increase. Increases to the extent of their purchase price. Surviving Owner’s Tax Basis If the amount received by the deceased owner’s estate equals the fair market value of the business interest at the owner’s death, there will be no taxable gain for federal income tax purposes. If certain requirements are met, the purchase price defined in the buy-sell agreement may fix the value of the business interest for federal estate tax purposes. If the amount received by the deceased owner’s estate equals the fair market value of the business interest at the owner’s death, there will be no taxable gain for federal income tax purposes. If certain requirements are met, the purchase price defined in the buy-sell agreement may fix the value of the business interest for federal estate tax purposes. Taxation of the Sale (prior to 2010) Entity Purchase Cross Purchase
  • 22. What Are the Other Features of an Insured Buy-Sell Plan? In addition to serving as a source of funding, an insured buy-sell plan can provide a variety of features:
    • Payment is prompt and certain. Life insurance proceeds are not subject to the time and expense of the probate process, making them immediately available to complete the purchase of the business interest.
    • The event creating the need for cash – an owner’s death – also creates a source of cash – the life insurance death benefit. The life insurance policy provides the dollars for a certain need – purchase of the business interest – that arises at an uncertain time – death.
  • 23. What Are the Other Features of an Insured Buy-Sell Plan? In addition to serving as a source of funding, an insured buy-sell plan can provide a variety of features:
    • If the death benefit exceeds the total premiums paid, this gain generally is received free of income tax. For example, if only 20 cents of each death benefit dollar received has been paid in premiums, the 80 cent gain is received income tax free!
    • Life insurance avoids the problems associated with the other methods for financing the purchase of a business interest at an owner’s death.
    • Any cash value in the life insurance policies could be used to help purchase the business interest at an owner’s disability or retirement (withdrawals and loans will reduce the policy’s death benefit and cash value available for use).