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