Many factors go into the decision of what approach a business owner takes in developing a buy-sell plan. But each type of plan–a stock redemption plan or a cross purchase plan–has both advantages and disadvantages.
First, lets discuss the drawbacks of each type of buy-sell plan, then well explore what elements should go into the "perfect" buy-sell plan and how to structure it.
The pitfalls of stock redemption plans. When working with the owners of a C-corporation, there are significant disadvantages associated with stock redemption plans. Perhaps the two most significant drawbacks are the absence of a proportionate increase in the cost basis of shareholders for stock redeemed by the corporation, and the potential exposure of corporate-owned policy cash values and death proceeds to alternative minimum tax (AMT).
In addition, state law may subject policy values and proceeds to the claims of corporate creditors or restrict the corporations ability to redeem shares. Also, the transfer of corporate-owned policies to shareholders can have undesirable income tax consequences, and the "attribution" rules relating to stock ownership can create difficult planning issues.
The downside of a cross-purchase plan. Unfortunately, a cross-purchase plan among the shareholders is not without its disadvantages as well. If the shareholders own policies and the corporation pays premiums, there are potential issues relating to "reasonable compensation" and/or "constructive dividends." These issues can be minimized with a split-dollar arrangement, but the actions of the IRS in 2002 have created uncertainty and confusion regarding this planning technique.
Because policies are owned by the shareholders, the corporation will have no control over them, and policy values will not be a balance sheet asset.
Finally, if there are numerous shareholders, the number of policies and administrative complexity of the agreement will be increased significantly.
Develop the "perfect" plan. Under perfect conditions, a buy-sell plan for a C-corporation with numerous shareholders would have all the following characteristics:
1. The purchase of shares would result in a full increase in cost basis to shareholders;
2. Elimination of the alternative minimum tax;
3. Protection of policy values and proceeds from business creditors;
4. Only one policy per shareholder would be required;
5. Business control over policies would be maintained;
6. The possibility of an income tax-free transfer of policies to the insured-shareholders would be created; and,
7. All potential "transfer-for-value" and "stock attribution" issues would be eliminated.
