by Robert J. Myers, Esq.

Why Buy-Sell Agreements are Important (Part 2)

ENTITY AND CROSS PURCHASE AGREEMENTS
The entity-purchase agreement is a contract within the company, not one among the partners or their families. In the case of XYZ, Ms. Smith and Mr. Gonzales would enter into a binding agreement with XYZ for the purchase and sale of their respective interests.Upon death, disability, retirement or resignation, Ms. Smith and Mr. Gonzales are obligated to sell their stock to XYZ and XYZ is obligated to buy that stock.
To fund this agreement, XYZ can obtain life insurance contracts on both Ms. Smith and Mr. Gonzales. XYZ pays the premiums and is the owner and beneficiary of the policies. When Mr. Gonzales dies, his stock passes to his estate. At the same time, the insurance company pays a death benefit to XYZ as beneficiary of the policy.
Pursuant to the entity-purchase agreement that Ms. Smith and Mr. Gonzales entered into with XYZ, Mr. Gonzales’ estate will transfer his entire interest in XYZ back to XYZ in return for the cash payout on Mr. Gonzales insurance policy. The entity-purchase agreement allows the value of the stock for estate tax purposes to be determined and gives the Gonzales family the liquidity they need.
Entity-purchase agreements do have some disadvantages. There will often be a build up of the value in the life insurance policy which may, along with the policy death benefits, be subject to the claims of corporate creditors and susceptible to alternative minimum tax.
In a cross-purchase agreement arrangement, XYZ is not a party to the agreement. Instead, Ms. Smith obtains a life insurance policy insuring Mr. Gonzales. Ms. Smith pays the premiums and is both owner and beneficiary of the policy. Mr. Gonzales does likewise. Under the terms of the cross-purchase agreement, each agrees to buy the other’s stock in the event of death using the proceeds of the life insurance policy.
When Mr. Gonzales dies, the insurance company pays the death benefits to Ms. Smith that she uses to buy back Mr. Gonzales’ interest in XYZ from Mr. Gonzales’ estate. Again, the Gonzales family gets the liquidity they need to settle his estate.
A cross-purchase agreement carries with it several advantages. First, it insulates cash values and death benefits from the imposition of corporate alternative minimum tax and corporate creditors. Second, it provides a step-up in cost basis for the surviving shareholder and the decedent. These are significant benefits when the surviving shareholder intends to sell the business following the death of the other partner.
One clear disadvantage of cross-purchase agreements occurs if the partners who are entering into the agreement are of different ages because the younger partner will pay more to insure the older partner.

Mr. Myers is the owner of Akerson Law Offices which is located at 1135 Pasadena Avenue South, Suite 140, St. Petersburg, Florida. The telephone number is 727-347-5131. Mr. Myers welcomes calls regarding this article and other related legal topics. This column outlines general legal principles and is not intended to give you legal advice. If you have a specific question about the law, please consult an attorney.
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