The Buy-Sell LLC Framework addresses many of the hurdles and issues related to the typical Buy-Sell Agreement.
Buy-Sell Agreements typically fall under two types of plans: Entity Plan & Cross-Purchase Plan.
1. Entity Plan
The Corporation (Partnership) buys the interest of the deceased (disabled) shareholder (or partner) at a pre-determined price or monthly payout.
2. Cross-Purchase Plan
Each surviving shareholder (or partner) agrees to purchase the interest of the deceased (disabled) shareholder at a designated price or monthly payout.
However, each of these plans have issues that may need to be addressed:
A. Entity Plan
1. No Step-Up in Basis (for surviving owners)
2. Business-Owned Life Insurance Could be Subject to Claims of Company Creditors
3. Possible AMT Exposure (Alternative Minimum Tax) for Large C Corporations (Business Owned Life Insurance)
4. Transfer-for-Value (TFV) Rule May Apply. TFV applies when a life insurance policy is transferred for valuable consideration. If applied, the TFV Rule makes the life insurance death benefit taxable.
B. Cross Purchase Plan (if funded via life/disability insurance)
1. Requires Purchase of Large Number of Life Insurance Policies (each owner owns policies of the other owners — example: 4 owner company requires the purchase of 12 Life Insurance Policies)
2. Life Insurance Policies are Personally Owned. As such, these policies may be subject to claims of personal creditors, ex-spouses, etc …
3. Uses “Honor System”. Each owner relies on the others to pay premiums on time, maintain the proper beneficiary designation, and not raid the policy for its built-up cash value.
4. Younger Owners May Resent Paying Higher Premiums on Life Insurance Policies for Older (and unhealthy) Owners.
5. Transfer-for-Value Rule May Apply (if shareholder added to an existing cross-purchase plan)
The LLC Buy-Sell Solution
The LLC Buy-Sell combines an LLC (Limited Liability Company) and a Cross-Purchase Plan.
4 Step Process
1. Form LLC
LLC is a separate (from underlying business), legal entity that will oversee and administer the buy-sell agreement.
2. Create Cross-Purchase Plan
Client’s attorney drafts a Cross-Purchase Buy-Sell Plan between the business owners (covers the Buy-Sell LLC and the underlying business).
3. LLC Purchases a Life Insurance Plan (Disability Insurance / Buy-Out Plan) on Each Business Owner
Typically, cash-value life insurance policies (whole life insurance / universal life insurance) are used as they can potentially provide funds for disability / retirement buy-outs. However, term life insurance plans can work as well.
4. Triggering Event Occurs
After a triggering event occurs (death / disability) to one of the owners, the Buy-Sell LLC receives the policy distribution and allocates funds to the Buy-Sell LLC members. The LLC members would then use the proceeds to purchase the equity of the deceased / incapacitated / exiting owner in the LLC and underlying business.
Advantages of the LLC Buy-Sell Plan?
1. Simple / Easy — only one life insurance plan per owner required / Buy-Sell LLC owns and pays premiums
2. Stepped-Up Basis — each participating owner may increase their cost basis per their purchase price share
3. *AMT / TFV — corporate AMT does not apply to an LLC / transferring a life insurance policy to a LLC co-owner does not trigger TFV rule
4. Creditor Protection — Buy-Sell LLC provides additional creditor protection (from creditors of underlying business and personal creditors)
5. For Retiring Owner — cash-value life insurance policy could be transferred to exiting owner as part of the purchase price (to reduce / pay for buy-out)
For business partners, the need for a solid Buy-Sell Agreement is similar to the need for a last will and testament for an individual. A Buy-Sell Agreement (using an LLC) could provide the benefits of a structured Buy-Sell Agreement without the hassle(s) and disadvantage(s) of the typical approach.
Please contact us to confidentially discuss your business and exit strategy options. We’d be happy to walk you through your options.
*Please note, all concepts, strategies, and products mentioned may not be suitable for you or your company. Information provided is not intended to be legal or tax advice. It is possible that the Transfer for Value Rule and other issues may apply on Life/Disability Insurance proceeds for a Buy-Sell Agreement. Please consult with your tax and legal advisor for specific tax questions.