Buy-Sell Agreement Life Insurance in Maryland
What is the purpose of a Buy-Sell Agreement?
A buy-sell agreement is a binding contract that ensures the continuation of a business in the case of a death or disability by one of the owners. This allows partners within a business to buy out the shares or interest of the other to retain full control and ownership of their business. Without a funded buy-sell agreement in Maryland, the heirs of the deceased partner will inherit their portion of the business. If no financial consideration is given to the deceased partners estate for those shares, the estate may choose to take over ownership or force liquidation of the business to receive such. These forced liquidations are often done at discount so that the estate may be settled in a timely manner.
Buy-Sell Agreement Life Insurance
The options to fund the buy-sell transaction are limited to the financial strength of the company, the deceased’s estate, and are rife with negative tax implications:
Surviving partners sell business to heirs: If surviving partners are prepared to exit and deceased’s estate is prepared to operate the business then this option would allow partners to receive more funds than in a liquidation. The question is where will the deceased’s estate get the money to actually purchase remaining partner's shares? How will revenue and lines of credit be affected by such a change in ownership?
Surviving partners buy business from heirs: If financially sound, surviving partners may feel their company can use profit from business operations or savings within retirement accounts to purchase the remaining shares. However the purchase of business interest is not a tax deductible event, such a purchase could be made with after-tax dollars only. Funding from qualified retirement accounts accessed early carry a 10% penalty and will be assessed for income taxes in the year of the distribution.
Seller Financing: The estate of the deceased could offer a plan for the surviving partners to slowly purchase back their shares of business out of the profit over time, but again this could only be done with after-tax dollars. More importantly, until all payments have been made to satisfy the agreed upon purchase price, the deceased’s estate will retain ownership rights to the company.
Buy-Sell Agreement Life Insurance: A specially designed life insurance contract can be issued on each partner of the business, payable to either the business itself or the remaining partners. The funds are immediately delivered upon death of owner and are tax free to the surviving partners and the deceased’s estate. If the surviving partners no longer want to retain the business, instead of using the funds to buy remaining shares, they may be used to fund their own buy-out by the estate or a third party of interest.
Types of Buy-Sell Agreement Life Insurance
Cross Purchase Agreement: This type of agreement is designed such that each partner has a policy that is payable to each other in the agreed upon value of their respective portions of the business. The death benefits are paid out directly to the surviving partners, who then use the payout to execute the continuation agreement. All distribution of funds are tax free. This type of agreement is most commonly done with five or fewer partners and is most advantageous to the deceased’s estate.
Entity Purchase Agreement: In this agreement, rather than the death benefit going to the individual partners, it is deposited in the business itself. The business then becomes the party to make the transaction with the deceased’s estate. Once shares are purchased all interests are automatically divided equally among the surviving partners. Recent court rulings (Connelly v. United States) have shown this type of transaction to have potential estate tax consequences for the deceased estate, making it more advantageous for the surviving partners.
Best Insurance Policy for a Buy-Sell Agreement
Index Universal Life Insurance: We truly despise making sweeping recommendations without having all the details, but the facts are 9/10 buy-sell agreements we implement are done through the IUL. This policy offers many advantages;
Flexible Premium and Adjustable Life: The IUL is the only permanent life insurance policy that can increase in death benefit without the insured having to go through additional underwriting. This allows the policy to easily adjust with the growth of the value of the enterprise. The premiums due on the IUL are different from other policies in that these can be lowered and raised as well. As long as the costs to meet the insurance coverage charges are met, this plan can again allow great flexibility in a uncertain business climate.
Indexed Cash Account; The cash value accrued in an IUL is given a annual interest based on how the major indices of the market perform, not a generic, lower fixed rate, found on most permanent policies. This means that excess cash can accrue within the policy that may not have in others. This cash can then go on to help fund loan operations and even serve as a severance or retirement package.
Without a written Buy-Sell agreement and a tax-free guaranteed fund for it, all of the continuation options for non-familial partners can be messy and complicated. Heirs often want money in return for their inherited share and are not capable or interested in running the business. Surviving partners usually want the business to continue and become sole owners or choose ownership using their own criteria. Any assets paid out that were not in a funded life insurance agreement are taxable events for all recipients, heirs, and surviving partners. This can result in major losses in value for all parties. Use this information to properly plan for continuation for your business, Bay Life can help if you so choose.
