Our Massachusetts Tax Planning Lawyer have complied the following to provide you with examples of certain tax implications of buy-sell agreements in a typical small corporation. Click on these links to read about Buy-Sell Agreements: an Overview and the Two Types of Buy-Sell Agreements.
A cross-purchase agreement is between or among the respective shareholders. They agree to purchase a fellow shareholder’s shares upon certain events, usually the shareholder’s death, disability, retirement, or other departure from the corporation. When a shareholder dies, the income tax basis in his shares is stepped up to their value on the date of death. Therefore, when the other shareholders purchase those shares, the decedent’s family has no gain so no tax liability from the sale. The transaction is also beneficial to the purchasers whose tax basis in the purchased shares is now the same stepped-up basis. Therefore, the purchasers realize less gain on these shares when they are later disposed of than they realize on disposition of their original shares, which typically have a lower basis from the time they were acquired.
In addition, if each purchaser is the beneficiary of a life insurance policy on a deceased shareholder, the insurance proceeds are income tax-free and do not need to be included in the estate of the deceased shareholder because he or she did not own the policies.
Cross-purchase agreements funded by insurance can become unwieldy, however, as the number of shareholders increases. To learn more, speak with our Cambridge Tax Planning Attorneys today!
In an entity-purchase agreement, the business entity itself is a party to contracts with each of its owners and agrees to buy out a departed shareholder’s shares. Because the business is the purchasing party, the surviving shareholders retain their original bases in their own shares, leading to higher capital gains when the shares are disposed of before death.
If the buy-out is to be funded by insurance, an entity purchase agreement is more manageable for a larger number of shareholders. For example, if there are 5 shareholders there would be an equal number of insurance policies (one on the life of each), instead of the 20 policies that would be required if the shareholders had a cross-purchase agreement.
The corporation must take into account the effect of the transaction on its earnings and profits, which will increase with the insurance proceeds and decrease with the stock purchase. Another key consideration is that the insurance proceeds to the corporation may have to be included in the deceased shareholder’s estate if he or she is a majority shareholder. This is because the shareholder’s controlling interest in the business is akin to an ownership interest in the policy.
As seen from this discussion, there are complex tax and legal implications in providing for the disposition of ownership interests in businesses. These require the assistance of an experienced Massachusetts business lawyer. At Ionson Law, our Massachusetts Tax Planning Lawyers can guide business owners as they plan and implement Buy-Sell Agreements.
Contact our Cambridge Tax Planning Attorney at 781-674-2562 to learn how we can help you!