Sole Proprietor
Unless a sole proprietor ( let ’ s call the person and “ owner ”) has a family member or a close relative to turn the business over to and feels comfortable the owner ’ s desires for his / her family members will be served , the options are limited . The business can be closed , it can be sold to an outsider , although small businesses are sometimes difficult to sell , or , if the owner wants his ‘ baby ’ to continue , it can be sold to one or more competent and faithful employees . The buy / sell agreement to a trusted employee becomes a two-step plan :
� an agreement is prepared which sets forth the employee ’ s obligation to buy , the price the employee ( s ) will pay for the business and the method of payment
� the employee takes out a life insurance policy on the owner . The employee is the owner of the policy , the person who pays the premiums and the beneficiary .
If the owner dies , the death benefits of the insurance policy would be used to buy the business from the owner ’ s estate .
Partnership
Partnerships are automatically dissolved with the death of one partner ; therefore , a buy / sell agreement is very important . In this case , a buy / sell agreement would sell the deceased ’ s interest in the company to the surviving partner ( s ) at an agreed to price . For partnerships there are two different plans :
� Cross-Purchase Plan – in this plan each partner buys a life insurance policy on each of the other partners . The partnership itself is not a participant in the agreement . Each partner owns , pays the premium payments and is the beneficiary of the insurance policies on the other partners in an amount equal to his share of the purchase price set forth in the buy / sell agreement . The proceeds are used to purchase the partner ’ s business interest from the heir ’ s of the deceased .
The number of policies required for a partnership with multiple partners would be the number of partners X ( number of partners-1 ). For example , a plan for a partnership with three partners would require six separate insurance policies . Each partner would need a policy on each of the other parties .
Let ’ s say a business worth $ 600,000 is owned by three partners in equal shares . Each partnership would be worth $ 200,000 and if one of the partners died , the other two partners would have to provide $ 100,000 each to equally purchase the deceased person ’ s share . Therefore , each partner , in this case , would take out a policy on each of the other two partners in the amount of $ 100,000 each .
� Entity Plan – in this plan partners enter into an agreement with the partnership who owns , pays the premium payments and is the beneficiary of the policies . When a partner dies , his / her interest is purchased from his / her estate by the partnership at the buy / sell agreement price and the interest is then divided among the surviving partners in proportion to their own interest .
In this case , the $ 600,000 business discussed above would purchase a $ 200,000 policy for each of the three partners . If one of the partners dies , the business pays the deceased partner ’ s share from the death benefit of the policy and distributes those shares equally to the two remaining partners . The remaining partners , in this case , would then each own 50 % of the business .
Because of origination funding , buy-ins , etc ., not all partnerships are owned equally by the partners . In those cases , both the insurance policy ’ s amounts and the benefits distributions would be made on the basis of each partner ’ s proportionate share in the business .
Additionally , none of the premium payments in the above plans are tax deductible ; however , the benefits are taxfree .
Closed Corporation
Unlike a partnership , a closed corporation ( i . e . a small number of shareholders who run the business ) does not cease to exist with the death of one of its shareholders . For closed corporations , there are also two different plans :
� Cross-purchase plan – each stockholder owns , pays for and is the beneficiary of life insurance on the other stockholders in amounts equivalent to his or her share of the purchase price . The corporation is not a party to the agreement . The surviving stockholders purchase the interest of the deceased stockholder as individuals from the estate of the deceased stockholder . This plan is like the cross-purchase plan described in the partnership section above . Obviously , the more shareholders the more difficult this plan becomes .
� Stock redemption plan – the corporation , rather than the stockholders , purchases the insurance policy , pays the insurance premiums and is the beneficiary on the lives of each shareholder . The amount of insurance on each stockholder is equal to the proportionate share of the purchase price . Upon the death of one of the stockholders , the death benefits are paid to the corporation who then buys the deceased ’ s stock from the deceased ’ s estate . Premiums are not taxed deductible but the proceeds are received income tax free .
Any agreements and insurance policies within a business must be integrated with the overall plan and objectives of the business . Careful consideration must be given to the selection of the plan which is right for your business and to the method of funding your plan .