by Karen Murphy, MostChoice.com

An important part of the business continuation plan is the buy/sell agreement -- a contract between two parties that defines how an owner will sell a particular interest in the business and how a buyer will buy that interest given certain situations.

Depending on their situation, the parties involved may choose the entity purchase, cross-purchase or the wait-and-see buy/sell agreement.

• Entity purchase -- provides that the corporation or partnership will buy back the interest of the departing owner. Most often, this type is used when there are multiple owners. The remaining owners' basis will stay as it was.
• Cross-purchase agreement -- an agreement between the owners outside the business. The owners agree to buy directly the interest of the seller on some prescribed basis, thus increasing their stated interest in the business. They receive an increase in their basis as result of the purchase.
• Wait-and-see -- allows the owners to defer the decision between the entity purchase and the cross purchase until such time as they can determine the most tax-wise strategy. This agreement benefits the seller by guaranteeing a buyer, providing liquidity, helping to avoid dividends and by possibly fixing the value for estate purposes. The agreement can benefit the buyer by eliminating potential friction at the time of sale, avoiding the possibility of hostile buyers, avoiding doing business with heirs and, if funded with life insurance, by providing the buyer with the cash to meet the purchase price.

Tax planning issues should be considered before choosing the type of buy/sell agreement to use. Seeking legal advice is highly encouraged in determining the best plan for your business. 

A good buy/sell agreement should also address such issues as as the method of business valuation, the type of buyout, and the triggering events, which may include retirement, divorce, withdrawal of employment, disability and death.

Should a triggering event such as death occur, agreements may give rise to a substantial contingent liability in which the obvious sources of funding, such as cash or third-party borrowing, may not be available. In this instance, life insurance can be an ideal funding vehicle for the buy/sell agreement.

It guarantees the proceeds will be available at an owner's death to purchase his or her interest, and allows for the buildup of tax-deferred cash value for a future buyout for something such as retirement.

With an entity purchase agreement, the partnership or corporation is the owner and beneficiary of the life insurance on the shareholders or partners.

In the case of a cross-purchase agreement, policies are owned by the individual shareholders or partners on the lives of each other. If there are more than three owners, however, policy ownership can become complicated and it may be wiser to use the entity purchase. As an alternative to this, you may establish a trust outside of the entity to hold the contracts and avoid multiple policies.

Also, when insuring a cross-purchase agreement, you may utilize a split-dollar funding technique in which the individuals own the policies and the corporation pays the premium, thus avoiding personal-income taxation on the full premium.

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