Many closely-held business owners devote the majority of their lives to developing a successful business.
Therefore, as part of their estate planning strategy, small business owners want to ensure that the worth of their business is properly valued, especially if the business must be sold in order to pay estate taxes. If drafted properly, a buy-sell agreement is an effective tool that can be used to set the value of a closely-held business interest.
Read more from Deanna Alger, CPA
A buy-sell agreement is an agreement between the owners of a business, which is used to provide for the purchase or sale of an ownership interest in the business at a price determined in accordance with the agreement, upon the occurrence of certain events. Triggering events include death, insolvency, bankruptcy, and transferring one’s interest to an outside third-party. In the case of a deceased business owner, buy-sell agreements serve many purposes.
- They provide a market for an otherwise unmarketable asset
- They ensure the deceased owner receives an agreed-upon value for their business interest
- They provide liquidity for the deceased owner’s estate
- They relieve the executor of the deceased owner’s estate of the task of negotiating price and terms
- They establish the value of the ownership interest for federal estate tax purposes. This can help to avoid expensive and distracting disagreements with the IRS over the value.
- They help to expedite the administration of the estate by establishing value in advance
- They help to minimize disputes among the spouse, children, and other heirs of the estate
Buy-sell agreements generally fall into one of three categories:
- Redemption/Liquidation Agreements: A redemption agreement is a contract between the business entity and the entity’s owners. When a triggering event occurs, such as the death of an owner, the entity is legally obligated to buy out (redeem) the withdrawing or deceased owner.
- Cross Purchase Agreements: A cross purchase agreement is a contract between the entity’s owners. When a triggering event occurs with respect to an owner, the agreement generally provides that the remaining co-owners will be legally obligated to buy out the deceased owner.
- Hybrid Agreements: A hybrid agreement is a mixture of a redemption agreement and cross purchase agreement. Upon a triggering event, the surviving co-owners have the right to refuse to buy out the withdrawing or deceased owner. If that right to refuse is exercised, the entity then becomes legally obligated to buy out the deceased owner’s interest.
Regardless of which type of agreement is used, a buy-sell agreement should seek to achieve three goals. First, the agreements ensure that there is a willing and ready buyer for the deceased owner’s interest. Second, if properly worded, the agreement should prevent existing owners from transferring interests to outside parties without the consent of all owners. Finally, the agreement can provide greater certainty about the federal estate tax outcome of the deceased owner.
The best time to establish a buy-sell agreement is now, before a triggering event takes place. If you currently do not have a buy-sell agreement for your business, Zinner and Co. would be happy to discuss the importance of them with you and your attorney and help to formulate the terms of your agreement.
Additionally, if you already have a buy-sell agreement in place, it would be beneficial to have one of our professionals review it in order to ensure that it is up to date and includes the appropriate language to protect your interest in the event of an ownership change.
If you have questions about your business, buy-sell agreements or how you can position your company to reduce your tax liablity, contact me a firstname.lastname@example.org or any of the tax professionals at 216.831.0733. We're ready to start the conversation!