Overview

A Cross-Purchase Agreement provides that the remaining shareholders will each purchase, pro rata, the interest of a departing partner / owner / shareholder upon the happening of a triggering event.

The shareholders enter into a binding agreement for the purchase and sale of their respective interests in the corporation. This agreement obligates the remaining shareholder to buy, and the departing shareholder to sell the shares of a departing shareholder at an agreed-upon or determinable price.

In a Cross-Purchase Agreement, only the remaining shareholders are obligated to purchase shares, allowing the corporation to remain a non-party to the agreement.

Mechanics

In order to fund their purchase obligations, each shareholder obtains life insurance on the other shareholders equal to their pro rata share of the insured's stock interest. Each shareholder is the owner and beneficiary of policies on the lives of the other shareholders.

Upon a shareholder's death, the surviving shareholders receive the policies' proceeds with which they purchase their share of the stock from the decedent's estate.

The decedent's estate receives a new, fair market valuation - a "step-up" in basis - for the stock owned at death (I.R.C. section 1014). As such, the decedent typically recognizes no capital gain pursuant to this sale.

Pros

  • Increase in Basis. The surviving shareholders receive an increase in their corporate basis commensurate with the purchase price of their shares.
  • Corporate Creditors. Corporate creditors have no recourse against the life insurance proceeds or policy cash values held by the shareholders.
  • Alternative Minimum Tax. Life insurance proceeds received by the shareholders will not increase the corporate alternative minimum tax liability.
  • Dividends. Cross-purchases do not give rise to dividend questions or attribution rules.
  • Transfer-for-Value. Policies can be transferred to the respective insureds without creating a transfer-for-value problem.

Cons

  • Multiple Policies. Funding a cross-purchase agreement with life insurance becomes increasingly difficult to administer with each additional shareholder.
  • Premium Payments. The shareholders may have difficulty paying premiums. The corporation may assist in these payments through either deductible bonuses or a split dollar plan.
  • Estate Inclusion. The cash value of policies owned on other shareholders' lives are includable in the decedent shareholder's estate.
  • Transfer-for-Value. In multi-party arrangements, interests in policies on other shareholders' lives acquired by a co-shareholder from a decedent's estate may create a transfer-for-value problem.

Action To Take

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Copyright 1998 Fielder Financial Management, LTD.
All Rights Reserved.

Securities and investment advisory services offered through Girard Securities, Inc. member FINRA, SIPC.
Fielder Financial Management, Ltd. not affiliated with Girard Securities, Inc.  Mark Fielder, OSJ, Registered Principal. CA. Insurance Lic. # 0690576.