One-Way Cross-Purchase
Buy-Sell Agreements
Business
Succession
Planning for the
Sole Owner
OLA 1957 0509
This material was not intended or written to be used,
and cannot be used, to avoid penalties imposed under
the Internal Revenue Code. This material was written to
support the promotion or marketing of the products,
services, and/or concepts addressed in this material.
Anyone to whom this material is promoted, marketed,
or recommended should consult with and rely solely
on their own independent advisors regarding their
particular situation and the concepts presented here.
The Sole Owner – Different from
Multi-Owner Companies
 Problematic – incapacity or premature death
 No co-owners to run company in interim
 No obvious successor
 May cause termination of entity
 Loss of stream of income for family
 Fire Sale – loss of significant percentage or
ALL value
What happens at owner’s death?
 Termination of business
 Sole Proprietorships
 Partnerships
 Professional Corporations
 Managed by Executor
 S Corporations
 C Corporations
 Limited Liability Companies
Bequeathing Business via Will
Common approach, but why is this a problem?
 Family members:
 Children often not involved in business
 Executor may not want to run business
 Successor not fully trained/mentored
 May not be qualified – lack professional certification
 Owner associated with Entity
 Loss of owner results in loss of goodwill
 Personal relationships with clients
 Personalized service only owner provided
One-Way Cross-Purchase
Buy-Sell Agreement
An alternative strategy.
 The owner will have negotiated a sale to a selected buyer prior
to death
 A sale is agreed to at a set price at a triggering event (death,
retirement, disability, specified date, etc.)
 Entity redemption not an option—entity cannot exist without an
owner/manager of operations.
One-Way Cross-Purchase
Buy-Sell Agreement
Pool of
Potential Buyers:
Key
Employee
Competitor
Relative
Potential
Buyer
Unrelated
Third
Party
Friend/
Colleague
One-Way Cross-Purchase
Buy-Sell Agreement
Buy-Sell Agreement contracts vary in terms, but all
contain following mandatory provisions:
 The owner (or his/her estate) will sell to the specific
buyer, and the buyer will purchase the business
interest from the owner
 An agreed upon price or formula to value the business
 Specified list of assets and liabilities to be transferred
 A means of funding, such as life insurance, is chosen
so buyer is capable of making purchase
Funding the Agreement – Term vs. Perm
Parties to agreement often want to fund with term insurance,
due to lower premiums, but permanent insurance may be more
appropriate because:
 Triggering event for buyout often occurs for reason other than
death (e.g. retirement, disability, specified date)
 Buyer can use cash accumulation in a permanent policy
to fund a lifetime buyout
 Permanent policy with cash value build-up works better for a
long held, well-established business
 Length of agreement may extend beyond time that term is
available (gets too costly after a certain age)
 At time participants want to switch to permanent, insured
may be in poor health or uninsurable.
Key Executive as Buyer –
Executive Bonus
Candidate to replace owner – Key Executive in Business
 As salaried employee, may lack funds for buyout
 Owner can implement Executive Bonus arrangement
to fund policy
 Premiums are paid through taxable bonus to executive
 Employer receives a §162m deduction (as compensation)
 Executive purchases life insurance policy
 Executive is owner and beneficiary of policy
 Employer may add “double bonus” to cover estimated
income tax liability to Executive on both bonuses
 Premiums are not tax deductible for Executive
 With a Restricted Bonus, executive has limited
access to cash value of policy based on certain
events (e.g. disability of owner)
Executive Bonus:
Here’s How it Works
Employer
Bonus Payment: Employer makes taxable
bonus payment to executive and receives
corresponding income tax deduction.1
Executive reports bonus as additional income.
Life
Insurance
Life Insurance Purchase: Executive uses bonus payment
(minus income taxes) to purchase life insurance policy.
Accessing Benefits: Executive has access to policy’s cash
value at predetermined time or specified event.
Executive receives death benefit, used to fund buyout of
owner’s business interest.
Executive
1
Provided amount of bonus is reasonable and employer retains no
ownership rights or beneficial interest in the policy.
Using an Escrowed
Buy-Sell Arrangement
Setting up the buy-sell agreement with an Escrow as intermediary
can serve many purposes:
 Ensures enforcement of the arrangement
 Prevents likelihood of buyer unilaterally backing out
of agreement after owner’s death, and keeping
policy proceeds.
 Custodian of life insurance policy
 Ensures payment of premiums
 Prevents access by creditors
 Preserves integrity of policy (prevents policy withdrawals,
which could cause lapse)
One-Way Cross-Purchase Buy-Sell:
Here’s How it Works
Example:
 Felix owns cleaning service, sole proprietorship
 At his death, company would liquidate
 Goals: To ensure his wife and children are taken care of after
his death with a lump sum or stream of income
Felix’s Cleaning Service
Felix, Sole Proprietor
How it Works Example –
Felix’s Cleaning Service
Example:
 Oscar was once one of the worst employees
 After many years, Oscar has shaped up and is the best, and
manages all the other cleaners
 Goals: Felix decides to choose Oscar to take over the business
when he leaves. Oscar jumps at the chance.
Oscar, Head Cleaner
Key Employee
How it Works Diagram –
Felix’s Cleaning Service
I. During Felix’s Life:
Sole Proprietorship
(Cleaning Service)
Sole Proprietor
(Felix/Felix’s Estate)
2) Employee Bonus/
Employer Deduction
4) Premiums
Transamerica
Policy
(on Felix)
1) Buy-Sell
Agreement
3) Income Tax
on Bonus
IRS
Buyer
(Oscar - Key Employee)
How it Works Diagram –
Felix’s Cleaning Service
Sole Proprietorship
(Cleaning Service)
II. At Felix’s Death:
Sole Proprietor
(Felix/Felix’s Estate)
7) Business Interest
6) Sale Proceeds
8) Income
Tax on
IRD
5) Death Benefit
Transamerica
Policy
IRS
Buyer
(Oscar - Key Employee)
Tax Consequences
 If employee bonus used:
 Deduction allowed for business
 Income must be recognized by Key Employee/Buyer
 Generally, policy death benefit federal income tax-free
 Owner’s estate receives step-up in basis at death, so no capital
gain in business likely to be realized
 Income in Respect of a Decedent (ex. notes, accounts
receivable, commissions received after death, substantially
appreciated inventory):
 No step-up in basis at death
 Subject to ordinary income tax
 If buyer predeceases owner, value of life insurance policy is
included in buyer’s estate
Effect of Estate Basis Step-Up
Lifetime Sale versus Estate Sale
The effect of the step up in basis received by an estate
is best understood through the use of an illustration.
Example: Owner creates a business and contributes $50,000 to its start up. After 7 years,
the value of the business has increased to $325,000. Assume that Owner’s basis remains
the same throughout that time.
Lifetime Sale
Estate Sale
If Owner sells the business now, he
would be liable for capital gains tax.
If Owner dies today and the estate sells
the business, the estate would receive a
step up basis in the business.
$325,000 Sale Proceeds
$325,000 Sale Proceeds
$50,000 Basis
$325,000 Basis Step-up
$275,000 Capital Gain
$0 Capital Gain
$41,250 Capital Gains Tax Due (15%)
$0 Capital Gains Tax Due
$283,750 Net to Owner
$325,000 Net to Owner’s Estate
Advantages
Sole Owner
 Known buyer at death
or retirement
 Plan for management of
business at death or retirement
 Sale proceeds a source of
income for family
 Pegged value of business
Key Executive/
Buyer
 Offer to own business
 Funding (life insurance) to
pay purchase price
 Basis in business interest
equal to purchase price
Transamerica Life Insurance Company, Transamerica Financial Life Insurance Company
(collectively “Transamerica”), and their representatives do not give tax or legal advice. This
material is provided for informational purposes only and should not be construed as tax or
legal advice. You should rely solely upon your own independent advisors regarding your
particular situation and the concepts presented here.
Discussions of the various planning strategies and issues are based on our understanding
of the applicable federal tax laws in effect at the time of presentation. However, tax laws are
subject to interpretation and change, and there is no guarantee that the relevant tax
authorities will accept Transamerica’s interpretations. Additionally, this material does not
consider the impact of
applicable state laws upon clients and prospects.
Although care is taken in preparing this material and presenting it accurately, Transamerica
disclaims any express or implied warranty as to the accuracy of any material contained
herein and any liability with respect to it. This information is current as of April 2009.
Transamerica Financial Life Insurance Company is authorized to conduct business in the
state of New York. Transamerica Life Insurance Company is authorized to conduct
business in all other states.
OLA 1957 0509
One-Way Cross-Purchase
Buy-Sell Agreements
Business
Succession
Planning for the
Sole Owner
OLA 1957 0509