There are three main options or ways to fund the Buy-Sell Agreement. I’m sure you won’t be surprised to find that most Buy-Sell Agreements are paid out using life insurance. In fact, the first two funding options deal with available options using life insurance:
1. The criss cross option
Under this option the life insurance is owned and paid for by the partner out of after tax income. In other words, life insurance are purchased and paid for by the partner or shareholder on each other’s life and the owners are the beneficiary. This is the primary and traditional method of structuring a buy-sell agreement and for sole proprietors and partners and it is the only option available for unincorporated businesses. Under the criss cross option, policies can be co-owned and paid for by split dollar arrangements.
2. Split dollar funding option
The second option to fund buy-sell agreement is split dollar funding option that is the pre-determined agreement between employer and employee on how to fund life insurance premiums. Split dollar funding became popular to fund several important functions.
a) Key man insurance and award.
b) Employee buy-out.
c) Corporate buy-sell agreements between shareholders and used as the incentive for a business to accommodate a split dollar buy-sell agreement
i) The premium payment creates unequal contributions due to extreme differences in the ages of the partners, or employees buy out the owner.
ii) If the employee is the son or daughter of the owner, it allows the siblings and heirs to be compensated in cash for their share of the business interest.
iii) It is particularly attractive in closely held corporations due to the lower corporate tax rate. This is not available to partners where the tax advantage is considerably less advantageous.
Whole life policy containing cash values is the best choice for life insurance used for buy-sell agreements.
3. Corporate repurchase and corporate redemption method
The third funding option for buy-sell agreements is the corporate repurchase or corporate redemption method. This is used solely by corporations, who may also use the criss-cross method. The corporate repurchase or corporate redemption method may be funded in one of two ways:
a) Cross-purchase agreement:
This technique is funded by tax free dividends. It provides for corporations:
i. To own the required amount of insurance on the lives of the shareholders.
ii. To pay the premiums.
iii. To be the named beneficiaries.
b) Corporate buy-back of shares.
Premiums of insurance are paid by the corporation.
I hope this information will help. If you need more information of the above subject, please visit my home page at:
Kyle J. Norton
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