If you are an owner of a business, what would happen if you or a co-owner were to die suddenly?Large problems can result from the death, incapacity, resignation, etc., of one of the owners. How would the decedent's heirs liquidate the business interest to pay expenses and taxes? What would happen if an heir or an unknown outside buyer of the decedent's share decides to interfere with the business? Could the business or other owners afford to buy back the decedent's ownership interest?
A solution for many businesses is a properly drafted buy-sell agreement. A buy-sell agreement can:
* Protect the company's remaining shareholders or partners from unwanted interference in the business, either from heirs or from third parties to whom an heir might sell the decedent's business interest;
* Guarantee a purchaser for a potentially difficult-to-market asset (the deceased owner's share of the operation);
* Establish the value of the deceased owner's business interest for federal estate tax purposes (either by setting a value or setting a way to determine the value); and,
* Provide liquidity to a deceased owner's estate.
There are various types of buy-sell agreements, but they are normally funded by purchasing life insurance.
The only way to deduct the funding for the agreement for tax purposes is to use a VEBA (www.vebaplan.com).
A VEBA makes the contribution tax-deductible and allows the benefit to be paid tax-free. Whatever type of buy-sell agreement is chosen, certain key tax issues should be addressed. If the buy-sell agreement is properly structured, it will fix the estate tax value of the decedent's share of the business, no matter what the fair market value of the interest might be. This can provide certainty in the owner's estate planning. However, there are many tax pitfalls, and failure to avoid them can result in the loss of this potential tax advantage.
Even if a buy-sell agreement is set up so that the Internal Revenue Service will likely accept the agreed-on value as the estate tax value, there are other considerations. For example, how will the agreement affect the tax and estate plans of the decedent's family and the remaining owners? By weighing all relevant factors, a buy-sell agreement can benefit all of the parties involved.
Funding of the buy-sell agreement also needs to be carefully planned. Most buy-sell arrangements are funded by life insurance. If properly utilized, life insurance is a key element to securing all the tax benefits offered by the arrangement.
Lance Wallach, CLU, ChFC, speaks and writes extensively about VEBAs, pension plans and tax reduction strategies. Reach him at (516) 938-5007 or (516) 935-7346.
