ESTATE PLANNING FOR BUSINESS OWNERS
Submitted By: Lynn A. Herald, CFA, Financial Advisor at Morgan Stanley Smith Barney LLC
on behalf of Morgan Stanley Smith Barney LLC
If you are an owner of or partner in a business, you may have an additional layer of estate planning to consider—especially since the business may be your family’s largest asset. Selling your interest in your business to managers or partners through a buy-sell agreement-a document that is binding upon the parties and usually drafted by an attorney- can be an effective strategy, especially since a funding mechanism can be built into the arrangement. There are two main types of buy-sell agreements:
Cross-purchase agreement— Made between business partners, this agreement spells out the terms by which each partner may buy out the other(s) in the event of death, disability or retirement. The remaining owners buy the departing owner’s share of the business at its current value. This creates an advantage for the remaining owners in that their cost basis in their new shares will equal the purchase price. This step up in basis may reduce their potential capital gains tax liability if they decide to sell their business interest in the future.
Entity purchase or stock redemption agreement— Established between the business and the business owners, this agreement sets forth the conditions under which the partnership or corporation agrees to buy an owner’s interest, such as the retirement or death of an owner. There is a potential disadvantage to this approach, however: In contrast to the cross-purchase agreement, an entity purchase agreement does not increase the remaining shareholders’ cost basis in the corporation. This could result in a significant capital gains tax when their interest in the business is sold. Both types of buy-sell agreements can be funded with life insurance purchased on the lives of the partners. For cross-purchase agreements, the number of policies purchased is calculated by multiplying the number of partners by the number of partners minus one. Each business owner buys a life insurance policy on all the other owners and pays the premiums for each policy. The entity purchase/stock redemption agreement requires only one policy on each owner’s life. The business is both the owner and the beneficiary of each policy and pays all premiums. Life insurance can also be used to allow business owners to purchase polices that provide a balanced inheritance for heirs who have no interest in receiving a share of the family business. In effect, life insurance benefits equalize the value received by all heirs—those receiving an interest in the business and those who do not. Overall, succession planning allows for a smooth transition and provides peace of mind. At Morgan Stanley Smith Barney, working in concert with their legal and tax advisors, we have helped countless entrepreneurs with succession planning discussions. We can bring objectivity to this important first step to succession planning.
Lynn A. Herald, CFA is a Financial Advisor at Morgan Stanley Smith Barney located in Coral Gables, FL and may be reached at 305-460-7902 or http://fa.smithbarney.com/lynnherald
Tax laws are complex and subject to change. This information is based on current federal tax laws in effect at the time this was written. Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Smith Barney’s Financial Advisors do not provide tax or legal advice. This material was not intended nor written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are urged to consult their personal tax or legal advisors to understand the tax and related consequences of any actions or investments described herein.
Articles are published for general information purposes and are not an offer or solicitation to sell or buy any securities or commodities. Any particular investment should be analyzed based on its terms and risks as they relate to your specific circumstances and objectives.
Investments and services offered through Morgan Stanley Smith Barney LLC, member SIPC.
© 2009 Morgan Stanley Smith Barney LLC. Member SIPC.
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