Sometimes it’s difficult to decide which type of buy sell agreement to recommend when dealing with QPSC, S Corp, and LLCs. Should it be a stock redemption plan funded with employer owned insurance or a cross purchase plan funded by cross owned insurance? Get expert insight from Russell E. Towers JD, CLU, ChFC Vice President, Business & Estate Planning at Brokers' Service Marketing Group ( A brokerage general agency for financial professionals).

1. For Agent Use Only. Not for public distribution
Buy Sell Planning for
QPSC, S Corp, and LLC
Professional Practice Owners
Russell E. Towers JD, CLU, ChFC
Vice President - Business & Estate Planning

2. For Agent Use Only. Not for public distribution
 Professional Practices where revenue is generated
by fees and/or commissions where capital is not a
material income producing factor:
 Medical and dental practices
 Law firms
 Accounting firms
 Architectural firms
 Fee based financial planning firms
 Independent insurance firms … life insurance,
property and casualty etc.
 Investment management firms
Professional Practices

3. For Agent Use Only. Not for public distribution
 Verify Fair Market Value (FMV) of professional
practice… 1-2 times gross annual revenue is typical.
More established firms will be at the higher end of range
 FMV appraisal from CPA firm with expertise in
professional practice valuation (ABV designation)
 Basic Considerations:
(a) QPSC, S Corp, LLC…
(b) Appraised Fair Market Value…
(c) Percentage Ownership of Each Owner...
(d) Type of Buy Sell Agreement
Business Financial Information

4. For Agent Use Only. Not for public distribution
 Collect personal financial information to compute a
Life Insurance Needs Analysis for each professional
business owner
 Determine total income protection, mortgage repayment,
college costs, final expenses, etc.
 If business value is LESS than total insurance
need, then sell two policies
Personal Financial Information
(1) Policy #1 as entity or cross
purchase buy sell.
• Death proceeds are used to
purchase shares from estate of
deceased business owner. Cash is
distributed from the estate to
spouse and family
(2) Policy #2 is owned
personally with spouse
beneficiary
• Or Irrevocable Trust for the benefit
of spouse and family depending on
facts of case

5. For Agent Use Only. Not for public distribution
 QPSC (IRC Section 448(d)(2)
Professionals) U.S. Form 1120
 Business income minus deductible
business expenses = net profit
 QPSC tax rate = flat 35%
Does not have marginal brackets ranging
from 15% to 35% like regular C Corp
Qualified Personal Service
Corp (QPSC) Taxation

6. For Agent Use Only. Not for public distribution
S Corp and LLC
Pass-Through Taxation
S Corp - Net Profit
Form 1120S
• Pass-Through of Net
Profit (K-1) to Personal
Tax Return of S Corp
Owners (Schedule E of
Form 1040)
• Accumulated Adjustment
Account (AAA)
reconciliation
(previously taxed profit)
LLC - Net Profit
Form 1065
• Pass-Through of Net
Profit (K-1) to Personal
Tax Return of LLC
Owners (Schedule E of
Form 1040)
• Capital Account
reconciliation
(previously taxed profit)

7. For Agent Use Only. Not for public distribution
 Legal Agreement to Purchase Shares at a Stated Price
 Finance the Obligation at the Lowest Cost
 Life Insurance Premiums transfers the financial risk
to an Insurance carrier
 Term, no-lapse UL, indexed UL, whole life
 Stock Redemption - Entity Plan
 Cross Purchase Plan
 Unilateral “One-Way” Purchase Plan
 “Wait and See” Optional Plan
 Cross Endorsement Buy Sell Plan
Business Continuation
Planning

8. For Agent Use Only. Not for public distribution
 Business entity (QPSC, S Corp, or LLC) is owner and beneficiary
of insurance. EOLI “Notice and Consent” rules apply.
 Entity is responsible to purchase shares from estate of deceased.
 Entity pays non-deductible insurance premiums which will be
part of K-1 “pass-through” profit for S Corp and LLC owners
 A “trusteed entity plan” may be used to provide additional
certainty that the plan will be executed properly
 (See IRC Section 1377(a)(2) for special S Corp redemption
“short tax year election” rules).
Stock Redemption / Entity Plan

9. For Agent Use Only. Not for public distribution
 Cost basis Adjustment for surviving owners
 *QPSC ….. 0% basis increase for survivors
 *S Corp ….. potential 100% basis increase for survivors equal
to purchase price under IRC Section 1377(a)(2) procedure.
Cash basis taxpayer. (1) Short term note payable (2) Short tax
year election (3) Collect insurance proceeds and allocate basis
to survivors (4) Pay off note to estate of deceased
 * LLC ….. Partial basis increase and partial “wasted basis” for
share of deceased (i.e. 25% owner = 25% “wasted basis” ….
75% basis increase for survivors)
Stock Redemption / Entity Plan

10. For Agent Use Only. Not for public distribution
 “EOLI” rules for “notice and consent” of IRC Section 101(j)
and IRS Notice 2009-48. Also note PLR 201217017 when a stock
redemption buy sell agreement and EOLI is involved.
 Written notice to insured in a timely manner prior to issuance of
policy
 IRS Form 8925 filed with business tax return
 If no timely compliance with “notice and consent” and death
occurs, then any death benefit in excess of cost basis is taxable
income
Employer Owned Life Insurance

11. For Agent Use Only. Not for public distribution
 Each share owner is owner and beneficiary of insurance on the life of
the other share owner(s)
 Surviving owner(s) are responsible to purchase shares from estate of
deceased. 100% cost basis increase equal to purchase price
 Entity may pay taxable bonus comp to owners to pay insurance
premiums
 Taxable K-1 profit distributions from S Corp or LLC may also fund
premiums
 A “trusteed cross purchase plan” may be used where 3 or more
owners are involved. Reduce the number of policies. Trustee will
manage the beneficial interests that each shareholder has in the
premiums, cash values, and death benefits on the lives of the other
shareholders (i.e. 3 owners = 6 policies … 4 owners = 12 policies)
Cross Purchase Plan

12. For Agent Use Only. Not for public distribution
 Non-owner professional (employee) is owner and
beneficiary of insurance on life of 100% share owner.
 Non-owner professional(s) are responsible to purchase
shares from estate of deceased 100% share owner. 100%
cost basis increase equal to purchase price
 Entity may pay taxable bonus comp to non-owner
professional (employee) to pay premiums.
 A “trusteed unilateral plan” may be used when there
are 2 or more non-owner (employee) professional buyers
Unilateral “One Way”
Buy Sell Plan

13. For Agent Use Only. Not for public distribution
 Typically insurance is arranged in cross purchase method
 However, agreement gives option to determine method of
purchase (stock redemption v. cross purchase) at death of share
owner. (i.e. 60-90 day options).
 If stock redemption is chosen, surviving owners collect death
proceeds and either:
A) loans cash to company (liability on books) or
B) makes a capital contribution (paid-in capital) of cash to
company …. to execute the redemption
 Either surviving share owner or business entity will be
responsible to purchase shares from estate of deceased
depending on which option is chosen
“Wait and See” Optional Plan

14. For Agent Use Only. Not for public distribution
 Useful when owners have maxed-out QRP contributions and
wish to save more for themselves AND cover a buy sell
obligation with the same insurance policy. Use a cash
accumulation type of policy - Indexed UL ,Whole Life
 Each owner enters into an endorsement - cross purchase business
agreement
 Each owns their own policy and endorses the death benefit to the
other owners via the beneficiary designation (irrevocable?).
Problem if owner/insured surrenders policy?
 Business can pay taxable bonus comp to each owner to pay
premiums. In addition, each policy owner reports income for
“economic benefit rental charge” based on Table 2001 rates
Cross Endorsement Buy Sell Plan

15. For Agent Use Only. Not for public distribution
 At death, survivors receive 100% cost basis increase when shares are
purchased from estate of deceased
 Death proceeds are included in gross estate of deceased but should be
offset by an equal estate tax deduction for the liability associated with the
buy sell agreement
 Each policy owner has access to tax free withdrawals and loans from
policy cash value as a non-qualified retirement supplement
 Note: Possible Transfer for Value issues with QPSC and S Corp
because the mutual promises of buy sell agreement could be viewed as
contractual “consideration” between co-shareholders. So, if TFV is an
issue, use this concept for LLCs. LLCs fall under the partner/partnership
exception to TFV rule. LLC could even be a business entity separate and
apart from the QPSC or S Corp
Cross Endorsement Buy Sell Plan

16. For Agent Use Only. Not for public distribution
 Often, the TFV Rule of IRC Section 101(a)(2)(B) comes into play to
re-arrange “title” to existing policies. To preserve income tax free death
proceeds, the transfer of ownership must meet one of the following
“exceptions”:
 Transfer to the insured. Also, a transfer to a “grantor trust” is
considered to be a transfer to the insured. The TFV rule is an income tax
rule, not an estate tax rule
 Transfer to a corporation where insured is an officer or shareholder.
However, transfer to co-shareholder of insured is NOT an exception.
This applies to QPSC and S Corp
 Transfer to a partner of the insured
 Transfer to a partnership where the insured is a partner
 Note: For purposes of the TFV rule, LLCs are considered to be partnerships
and LLC members are considered to be partners
Transfer for Value (TFV)

17. For Agent Use Only. Not for public distribution
Case Study
• S Corp with four owners (doctors, lawyers, CPAs), each 25%
shareholders, and firm has estimated FMV of $4 million
($1 million each). A Life Insurance Needs Analysis reveals a
total insurance family protection need of $2.5 million for your
client who is one of the 25% S Corp owners
Situation
• $1 million insurance on life of each 25% shareholder, with
owner and beneficiary the S Corp, to fund a stock redemption
buy sell agreement with “short tax year” election language … PLUS
$1.5 million of personally owned insurance with spouse as
beneficiary =$2.5 million total need covered with two policies
Solution
• (1) term insurance
• (2) no-lapse UL
• (3) indexed UL
• (4) whole life
Product Choices

18. For Agent Use Only. Not for public distribution
 Professional Owner Survives to Retirement
 Buy sell agreement typically requires an installment sale
purchase of the retiring professional owner’s shares over a
period of time with interest at the AFR rate in effect
(IRC Section 1274(d)).
 Either the business entity or the remaining owners personally
must pay the retiring owner over 10-15-20 years from the
operating revenue of the firm, accumulated sinking fund... or
from other personal or borrowed funds.
 Retiring owner reports income under the Installment Sale
rules of IRC Section 453 each year (1) ordinary income on
interest (2) capital gain on shares and (3) tax free recovery of
cost basis of shares... spread over 10-15-20 years of payment
Lifetime Sale of Business
Shares

19. For Agent Use Only. Not for public distribution
 10 year amortized payment = $123,290 annually
 Tax free cost basis ($100,000 /10 = $10,000 annually)
 Capital gain ($900,000 / 10 = $90,000 annually)
 Ordinary income ($23,290 annually)
Case Study
• One of the owners of a professional S Corp has reached age 70
and is retiring under the installment sale terms of the stock
redemption buy sell agreement. His interest is valued at $1
million. What does the S Corp have to pay if the retiring
owner’s shares are purchased with an amortized 10 year
installment note at 4% interest?
Situation
• Assuming amortized (equal) installment payments over 10 years
at 4%, and a cost basis of $100,000, here is the retiring seller’s
payment breakdown each year for 10 years
Calculation

20. For Agent Use Only. Not for public distribution
 Future operating cash flow of the S Corp or …
 Significant down payment plus installment sale for the
remainder. This down payment could come from the cash value of a
cash accumulation type of life insurance policy owned by the S Corp
(i.e. indexed UL or whole life)
 This policy does “triple duty” … (1) it protects against an early death
which would trigger a purchase of the shares from the estate of the
deceased owner (2) it accumulates cash value for a down payment
toward a lifetime installment purchase from a retiring S Corp owner
(3) it can provide tax free death benefit “cost recovery” for the firm
after the firm has used its operating cash flow for a lifetime buy out
Case Study
• How will the S Corp pay the $123,290
annually for 10 years to purchase (redeem)
the shares of the retiring 70 year old share
owner?
Question

21. For Agent Use Only. Not for public distribution
 Life Insurance Funded Buy Sell Agreements
Perform Important Functions
1) A buyer for each owner’s shares is guaranteed
2) The sale price is fixed in a legally enforceable
agreement
3) The funding for the legal obligation is provided by tax
free life insurance
4) Cash liquidity equal to the purchase price is provided
to the family of the deceased
5) Life insurance premium is the lowest present value
cost to accomplish the intended transfer of shares
Buy Sell Summary

22. For Agent Use Only. Not for public distribution
Russell E. Towers JD, CLU, ChFC
Vice President, Business & Estate Planning
500 South Main Street
Providence, RI 02903
888.523.1162 Option 3
russ@bsmg.net
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