Tax Treatment Of Buy Sell Agreements

The general rule applicable to a share withdrawal agreement varies widely. A shareholder who returns his shares receives a dividend. The treatment of dividends is detrimental because (1) dividends are treated as ordinary income (subject to higher tax rates than capital gains) and (2) the total amount received is taxed without compensation for the base of the repaid shares. Fortunately, there are several exceptions to the general rule that imposes dividend treatment and, if carefully planned, dividend processing can often be avoided. In addition, a purchase and sale contract may have negative effects on the use of family limited partnerships or similar instruments that create valuation discounts. Business owners may also find that a better price can be obtained for the business if it is sold during their lifetime from a key owner and not after their death. A buy/sell contract is usually structured in two ways – as a cross-sale or withdrawal contract. If life insurance is not available due to a member`s age or health, it is possible to fully finance the purchase/sale contract with a debt instrument payable over an extended period. The bond must be secured by assets and/or personally guaranteed by other members. This approach reduces or eliminates insurance transportation costs, but also increases the risk of existing members and has a negative impact on the company`s balance sheet. Determining the value of an LLC interest before a client`s death makes it possible to identify and quantify the liquidity needs of the client`s estate.

A properly structured buy/sell agreement can help determine this value. However, if the valuation rules of a purchase/sale agreement are not accounted for for inheritance tax purposes, the estate may face costly valuation disputes with the IRS and possible liquidity issues. If you have a stake in a family business or other nearby business, a purchase-sale contract is a valuable document. These agreements determine whether and under what circumstances the interests of the owners may be transferred. Buy-sell contracts should be carefully planned and designed to ensure that they meet your expectations and do not cause tax consequences or unwanted conflicts with other owners or family members. Fortunately, there are several exceptions that allow a transfer of value without taxing the insurance proceeds. Exceptions applicable to a purchase-sale contract include the transfer of a policy to (1) the insured, (2) a partner of the insured, (3) a partnership in which the insured is a partner or (4) a company in which the insured is a shareholder or officer. Value transfer problems are less common for share repurchase contracts than for share transfer contracts, since an insurance policy may exceptionally be transferred to a company in which the insured is a shareholder. The tax consequences of a purchase and sale contract concluded by co-owners of a company have complex tax consequences. However, it is not the value of the policy that will affect the estate tax, but the value of the businesses themselves that will be included in the net value of the property in the estate. Typically, purchase-sale agreements achieve these objectives by requiring or authorizing the remaining business or owners to acquire shares from an owner who dies, is disabled, or leaves the business. You can also give a right of pre-emption to the company or other owners if an owner wants to sell their shares.

The general rule does not apply when certain conditions are met. Careful compliance with these requirements makes it possible to use the buy/sell agreement to determine the value of the narrow activity for transfer tax purposes….

About the Author