Funding a Buy-Sell Agreement with Life Insurance
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Why Should I Consider or Reconsider a Buy-Sell Agreements with Life Insurance
Buy-Sell agreements are one of the most important elements in the planning for any business’s long-term success. A buy-sell agreement is a contract created by business owners to help ensure that if one of the members passes away-or becomes disabled or retires-then that persons’ ownership interest will be sold to the remaining partners or company. A life insurance buy-sell agreement requires the business owners to carry life insurance that benefits each other or the business. This allows the proceeds of the life insurance policy to be available to pay for the deceased member’s ownership interest.
A general belief is that a life insurance-backed buy-sell agreement helps ensure that stable ownership continues even If one business owner passes away. Using life insurance with a buy-sell agreement is possible if each business owner takes out a life insurance policy with the other members of the company as the beneficiary. The face amount of the policy is equal to the value of that member’s ownership interest. Should that member die, the policy pays out to the company or remaining owners. This provides funds they need to purchase the deceased members shares.
Why is a Buy-Sell Agreement News Now?
This practice cannot be utilized without setting terms and a price through the buy-sell agreement. It has become a hot button for the IRS. The IRS wants to determine to what extent such agreements can be used to set the value in an estate and gift tax purpose. Current law states that a buy-sell price is binding for federal estate and gift tax purposes if it meets specific criteria. This includes that the price must be fixed as of a determinable date; the agreement must be binding to the parties during life and after death; and the agreement must reflect the fair market value price at the time of execution.
In a recent case Connelly v. US (No. 23-146), a private business and the IRS are in conflict. Although the life insurance proceeds in the case were earmarked for stock redemption, the agreement did not set the price beforehand. The estate and the IRS agreed on a base valuation; however, the IRS contends the $3 million of life insurance proceeds should be added to the fair market value. Th case was decided by the Supreme court at the end of March, but the decision hasn’t been made public yet.
With this issue under review at the federal level, businesses should review their business models. If you currently own a business that has a buy-sell agreement and that business has purchased life insurance on the lives of the business owners to fund the buyout at the death of an owner, you should contact your attorney, accountant, and life insurance professional to review the current status of these matters in light of this recent Court decision.