FFM - Stock Redemption Agreement

Overview

A Stock Redemption Agreement provides that the corporation will purchase the interest of a departing shareholder upon the occurrence of a triggering event.

The shareholders enter into a binding agreement with the corporation for the purchase of the shareholders' business interests. This agreement obligates the shareholders and their estates to sell, and the corporation to buy the shares of a departing shareholder at an agreed-upon or determinable price. In the Redemption Agreement, only the corporation is obligated to purchase shares.

Mechanics

The corporation obtains life insurance on each shareholder's life equal to the value of that shareholder's interest in the corporation, naming itself both owner and beneficiary of the policies. Corporate premium payments, in this scenario, are non-deductible expenses [I.R.C. section 264(a)(1)].

Upon a shareholder's death, the corporation receives the policy proceeds federally income tax free. The shareholder's estate then sells (pursuant to the Buy-Sell Agreement) the decedent-shareholder's entire stock interest to the corporation in return for cash generated by the life insurance policy.

Pros

Simplicity. The stock redemption is uncomplicated and simple to effectuate.

One Life Insurance Policy Per Shareholder. The plan requires only one life insurance policy for each shareholder.

Corporate Premiums. The corporation pays the policy premiums, thereby imposing no direct burden on the shareholders.

Insurance is an Asset. The cash value of life insurance policies are carried as assets on the corporation's balance sheet without concerns of excess accumulated earnings, assuming the cash values do not exceed the reasonable needs of the business.

Access to Cash. At the termination of the buy-sell agreement, the corporation may access cash values in the policies to fund deferred compensation obligations.

Cons

No Step-Up in Basis. The surviving shareholders' basis in the corporation remains the same, although the value of their business interests increases.

Corporate Creditors. Corporate creditors can make claims against cash values of corporate owned life insurance, possibly depleting the Buy-Sell funding mechanism.

Alternative Minimum Tax. Life Insurance cash values and death proceeds may result in corporate alternative minimum tax.

Tax-Bracket Leveraging. Nondeductible premium payments are more costly if the corporation is in a higher tax bracket than the shareholders.

Action To Take

As with any investment, business planning or estate preservation product and strategy, it is wise to consult with professionals in the field, such as us. We have established and funded Buy-Sell Agreements for both small and large size businesses.

To request general information on Stock Redemption Agreements, please click HERE.

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Mark R. Fielder, Registered Principal. CA. Insurance Lic. # 0690576.