Taxation of Buy/Sell Agreements
If you are a business owner with one or more business partners, hopefully, you have a finalized buy/sell agreement. This contract outlines the details and process concerning the buying and selling of a business owners’ interest if they pass away or become incapacitated. Running a business is difficult and can become even harder if you have to do business with an heir who is ill-equipped to carry on the management of the business.
Buy/Sell agreements are often funded with life insurance and can be classified in two ways: cross-purchase or redemption/entity-owned agreements. The difference is whether you personally own the policy on your partner(s), or if the company owns the policy. There are many factors to consider when choosing which route to take, but below are the tax implications of both.
Cross Purchase Agreement (Personally Owned)
- Premiums are not deductible
- Death benefit is received tax-free
- After purchasing the deceased owner’s shares, the remaining owner(s) have an increased cost basis in newly acquired shares
Redemption Agreement (Entity Owned)
- Premiums are a deductible business expense
- Death benefit is taxable income to the company
- After purchasing the deceased owner’s shares, the remaining owner(s) have an increased cost basis in newly acquired shares
You must evaluate whether it’s more advantageous to take a tax deduction for the premiums or receive the death benefit tax-free. If you are unsure, or don’t have a buy/sell agreement established yet, let us know. We can help you consult with your professional team (CPA and attorney) to ensure you properly calculated the tax implications of your buy/sell agreement.
Gift-ology
By: John Ruhlin
