proceeds are payable to the purchasing shareholders . To the extent that a shareholder then uses his / her share of these tax-free proceeds to purchase shares of the selling shareholder , the purchasing shareholder will have a corresponding increase in the tax basis of his / her shares . So , for example , if a shareholder had originally purchased 100 shares of stock in the company for a total $ 1,000 when it was first formed many years ago , and he now purchases 50 additional shares upon the death of one of the other shareholders using $ 50,000 of life insurance proceeds , the purchasing shareholder will now own 150 shares of stock with a tax basis of $ 51,000 . As a result , A has used his $ 50,000 in tax-free life insurance proceeds to increase his basis by $ 50,000 , which will ultimately reduce his tax liability by $ 50,000 when he sells his shares . Note also that , while company-owned life insurance policies are subject to the claims of the company ’ s creditors , individually owned policies are not subject to the claims of the individual ’ s creditors under Indiana law .
There are , however , several disadvantages to a cross-purchase agreement . First , each shareholder will need to rely on his / her fellow shareholders to maintain the necessary insurance in force , and to have sufficient solvency to fulfill his / her purchase obligation in the case of an uninsured event that triggers a purchase obligation . Second , maintaining the required insurance policies becomes administratively cumbersome if there are more than two shareholders . For example , if there are three shareholders ( A , B , and C ), six insurance policies will need to be in place : A would have policies on B and C , B would have policies on A and C , and C would have policies on A and B . If there are four shareholders , twelve policies would need to be put in place . Third , there could be significant differences in the premiums that each shareholder would be required to pay as a result of age differences and medical issues affecting the individuals insured by those policies . Although it is possible to address some or all of these disadvantages by having the required policies owned by a trust of which the shareholders are the beneficiaries , that creates certain additional expenses and complexities .
III . Hybrid Agreements .
Hybrid buy-sell agreements can create certain rights and obligations for both the company and the shareholders . For example , a hybrid agreement could create a cross-purchase obligation among the shareholders in the case of death , where the obligation can be fully insured , but provide for a redemption by the company in instances where the repurchase obligation is not insurable ( such as upon a shareholder ’ s retirement ). Alternatively , a hybrid agreement could provide the shareholders with an option to purchase the offered shares on a pro-rata basis , with the corporation then having the option or obligation ( depending upon how the agreement is structured ) to purchase any shares not purchased by the shareholder . Thus , a hybrid buy-sell agreement can help avoid some of the disadvantages of both redemption agreements and cross-purchase agreements .
* * * * * * * Not surprisingly , there is no “ one-size fits all ” buy-sell agreement . Prudent business owners will want to evaluate their own unique circumstances and confer with experienced legal counsel to create the buy-sell agreement that best suits their needs and addresses their concerns .
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Riley Bennett Egloff LLP - July 2021