The Entity Purchase Buy Sell is one form of Business Sucession agreements. Let’s quickly review what a Buy Sell Plan is. A Buy Sell Plan is a legally binding agreement that spells out what happens to a business when a specific event occurs. In addition it establishes a fair market value of the business. How does the ENTITY Buy Sell work?
The first concept to understand is that the Business or Entity is the major player in this Buy Sell Program. Hence the term ENTITY BUY SELL Plan. The business agrees to purchase the shareholder’s part of a business upon the occurance of a specific event. Within this same agreement, the shareholder’s estate agrees to sell the shareholder’s interest upon the same event. We discussed these specific events to be a retirement, disability, divorce, death, bankruptcy or incapacity. This agreement, as with all other forms, is ideally funded to provide cash to execute the buy sell plan. In later articles we will discuss the several options business owners have to accumulate cash to fund their buy sell plans. For now, simply keep in mind that the ideal situation is to fund the buy sell agreement.
Now as we stated in other articles you have many choices as to which type of Buy Sell Plan to use. To help decide if the Entity Plan is a good fit for your business, we’ll discuss the advantages and disadvantages of this form of an agreement.
There are essentially four (4) favorable points for this Buy Sell program.
* Works well when there are three or more owners
*It’s fairly easy to understand and administer
* There is only one plan/policy for each owner
* Generally the business assets are used to purchase the policy to fund plan
However, there are several drawbacks in this type of agreement.
* There is NO STEP UP IN BASIS.
*It also could trigger an Alternative Minimum Tax (AMT)
* The cash value in a buy-out could be subject to claims of creditors
* It could trigger FAMILY ATTRIBUTION RULES
This applies to family owned corporations. Under IRS Code 318, If the corporation redeems all of the shares of a deceased owners estate AND the deceased owners child is the beneficiary of the estate, then the redemption may be treated as a taxable distribution and NOT a TAX FREE SALE.
Lastly, please keep in mind that such agreements fall under a fairly new section of the IRS. It is refered to as Section 101 (j) and concerns itself with Death Benefits from employer owned Life Insurance policies. It states that corporate owned Life Insurance policies will be subject to federal income taxes above the premiums paid. However, with proper planning, such taxes can be avoided with NOTICE AND CONSENT. When proper written notice has been given to the employee AND form 8925 has been filed with the tax return, the taxation issue should be avoided. I can provide you with Form 8925.
This plan could be a fit for your business. However, as we’ve been emphasizing throughout this whole program, it’s of paramount importance to sit down with a financial consultant, an attorney and your accountant to discuss if this plan is in your best interests. I would add, in closing, to factor all aspects of your total financial plan: your retirement account, projected business growth, employees, cash reserves and all other related topics. I do offer a free, no obligation plan overview to assist you in this planning.