For simplicity , this article uses the terms “ shares ” and “ shareholders ,” which would apply in the case of a corporation . However , this discussion is equally applicable to “ membership units ” and “ members ” in a limited liability company .
I .
Redemption Agreement
When a buy-sell agreement is structured as a “ redemption agreement ,” the company itself will have either the option or the obligation ( depending upon the agreement ’ s design ) to purchase the shares in the event of any proposed or impending transfer . A company will often obtain insurance to assist with the funding of a repurchase arising out of the death or disability of a shareholder , although the premiums paid are not tax-deductible .
The advantage of a redemption agreement is that the company , rather than the individual shareholders , will be responsible for funding the purchase of the shares . In contrast to a cross-purchase agreement ( discussed below ), only one policy per shareholder is necessary . In the case of a repurchase obligation not funded ( or not fully funded ) by insurance , the company may have greater resources to make the required payment than would the individual shareholders , including the ability to borrow the required funds , if necessary . Moreover , if for any reason the corporation were unable to fulfill its obligation to pay for the shares , the remaining shareholders would have no personal liability for that payment .
The disadvantages of a redemption agreement include the fact that , like any other company asset , insurance policies owned by a company are subject to the claims of the company ’ s creditors . In addition , there are a number of potential tax disadvantages . To the extent that a company wanted to reserve funds to assist with any repurchase not covered ( or not fully covered ) by insurance proceeds , the owners would nonetheless be taxed on the reserved funds if the company is a pass-through entity ( such as an S-Corporation or an LLC that is taxed as a partnership ), and the set-aside funds could be subject to the accumulated earnings tax liability in the case of a C-Corporation . Additionally , the redemption of a shareholder ’ s shares by the company will not have the same favorable effect on the tax basis of the other shareholders as would be the case with a cross-purchase agreement ( see below ). Lastly , in the case of a family-owned business , certain attribution rules may apply , as a result of which the redemption price could be treated as a dividend for tax purposes .
II .
Cross-Purchase Agreement
When a buy-sell agreement is structured as a “ cross-purchase agreement ,” each of the other shareholders will have either the option or the obligation ( depending upon the design of the agreement ) to purchase his / her prorata portion of the shares involved in any proposed or impending transfer . For example , if A owns 100 shares , B owns 50 shares , C owns 50 shares , and C dies , A would repurchase 2 / 3 ’ s of C ’ s shares ( since A owns 2 / 3 ’ s of the combined total of A and B ’ s shares ) and B would purchase the remaining 1 / 3 of C ’ s shares . A typical crosspurchase agreement will require each shareholder to purchase life insurance on each of the other shareholders to provide the purchasing shareholder with the money to fund the repurchase obligation . Once again , however , the premiums paid for this insurance coverage are not tax-deductible .
One advantage of a cross-purchase agreement exists in the case of the death of a shareholder , where life insurance
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