Buy-Sell Agreements (A Special Type of Stockholders Agreement)

Buy-Sell Agreements
(A Special Type of Stockholders Agreement)

A seminar presented by Scott Dondershine, Esq., CPA

Goals of Stockholder Agreements

  • Restrict Transfer of Shares During Lifetime
  • Lock in the Value of Shares for Estate Tax Purposes
  • Provide a Market for Shares Upon Death of a Stockholder or Termination of Employment
  • Secure Successful Transition of Business from One Generation to the Next

Restriction on Transfer of Shares

  • Desired sale to third party
  • Bankruptcy or divorce
  • Gift or pledge
  • Termination: For Cause and Not For Cause
  • Death
  • Drag Along

Lock in Value for Estate Tax Purposes

  • Need to:
    • Formulate mechanism for valuing shares
    • Agreement must have valid business purpose
    • Estate must be obligated to sell
    • Agreement must be binding for lifetime transfers (generally, same price as at death)
  • Minimize audit exposure
  • Save a lot of estate taxes and attorney fees
  • A lot of agreements do not sufficiently consider this issue

Provide a Market for Shares

  • Insurance proceeds
    • Death
    • Disability
    • Retirement or other termination of employment - CSV

Business Succession

  • Who will inherit?
    • Kids
    • Spouse
    • Creditors
    • Key employees

Types of Buy-Sell Agreements

  • Cross-Purchase
    • Increase in basis
    • Can be complicated if have more than three or four stockholders: Each stockholder needs to own policy on life of every other stockholder unless use LLC
  • Stock Redemption
    • No increase in basis
    • Potential AMT problem
    • Avoid potential dividend treatment if not buying all shares
    • Probably easier to administer

Transfer for Value Pitfall

Recipient Generally Not Taxed On Receipt of Proceeds

Exception that results in tax: If swap policies to start agreement or other transfer occurs

Very easy to fall into this trap - even if co-own policies to reduce required number

Potential solution if problem difficult to otherwise avoid: Have LLC own policies

Who Pays Premiums?

  • Recognize income tax issues
  • Possible use of split-dollar funding arrangement where corporation pays premiums but shareholder owns all or portion of policy

Who Owns Policy?

  • If cross-purchase - shareholders need to own policies
  • If redemption - company needs to own policies
  • Possible use of split-dollar arrangement or LLC

What Happens to Excess Proceeds (if any)?

  • If don't pay attention - you are rolling the dice
  • Generally, excess should be retained by owner of policy: corporation or other stockholders

Summary

  • Very important tool to consider even if estate and gift taxes are repealed
  • But, must carefully consider all issues since there are many traps for the unwary