One Way Buy Sell Agreement

The closely held business, with few owners that are many times family members, is often under-served when it comes to succession planning. This can be due to the lack of clear succession because family tends to focus on growing the business, assuming another family member will take over. Sometimes business owners simply do not understand available options or even possible consequences of doing nothing. Complacency and lack of planning can be a killer, but the good news is the One Way Buy Sell Agreement may be the solution.

One Way Buy Sell Agreements, especially when funded with life insurance, are flexible enough to motivate action. The One-way Buy-sell option can be structured to maximize tax efficiency, maintain total long-term control and allow for important legacy or estate planning considerations.

I have known the proprietor of East Coast Financial for over 20 years and from the day I met him, to shortly after when he managed my money, I knew he and his organization is one I could trust.

– Robert Leaman | Former Owner Compressed Gas Solutions

One Way Buy Sell Agreement
There Are Two Types Of One-way Buy-sell Structures:
The Bonus Structure featuring a current tax deduction, and the Endorsement Split-dollar which provides the owner long-term control.

The bonus structure is the most straightforward and most utilized one-way buy sell setup when dealing with family businesses whose plan is for the next generation to assume control. Premiums are advanced (the business or business owner pays the premium as an advance) to the family member employee(s) as tax-deductible compensation to purchase life insurance coverage on the business owner.

The business can “gross up” the extra compensation to account for all taxes, making the transaction income tax neutral to the recipient(s), while being fully tax deductible to business. The equity in the life insurance contract can serve as a sinking fund to provide down payment on a lifetime sale.
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When the business owner passes, the life insurance pays out tax free and is used, as stipulated in the buy sell agreement, to buyout the deceased owner’s spouse or the deceased owner’s estate – this buyout price establishes the new owners basis in the business. Remember, the new owner is the family employee or employee that was advanced the premiums to pay the policy that would eventually become the funding vehicle that facilitated the transition of ownership to him or her, from the deceased business owners estate.
Furthermore, some closely held businesses may be large enough to have estate tax planning considerations, this one-way buy sell bonus structure provides liquidity outside the deceased owner’s taxable estate that can be used by heirs to pay estate taxes. This leverages business dollars to create funds for heirs from tax-free life insurance held outside the estate. This is done in a tax-deductible manner, while preserving legitimate estate planning practices. If the owner decides to sell, gift or otherwise dispose of the business during his or her lifetime, the employee typically has the right of first refusal under a buy-sell agreement.
The bonus one-way buy-sell can accomplish a lot, while ensuring smooth legacy planning for future generations involved in the family business. However, it is important to note that this structure works best where involved parties have a vested interest due to their inherent lineage.
When “control” becomes more important than “tax deduction,” the business owner can personally own the life insurance policy and endorse a portion of the death benefit to the key employee. The key employee will have to recognize the economic benefit of the death benefit that will, in the future, be received tax free. It is best to discuss these effects with a CPA, but in general these benefits are treated like rent and paid.
If a key employee from outside the family lineage is expected to takeover, the business may consider funding the buyout plan with an endorsement split-dollar buy-sell agreement. Most split-dollar life insurance strategies can be set up between individuals (private split-dollar) or by means of an irrevocable life insurance trust (ILIT).
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One Way Buy Sell Agreement

In a split-dollar plan, an employer and employee execute a written agreement that details how they will share the premium cost, cash value, and death benefit of whatever permanent life policy that is used. Split-dollar plans are frequently used by employers to benefits to and to retain key employees. Or, as mentioned above can be used to pass the business to an outside key employee or other individual. 

One Way Buy Sell Agreement

The agreement outlines what the employee needs to accomplish, how long the plan will stay in effect, and how the plan will be terminated. It also includes provisions that restrict or end benefits if the employee decides to terminate employment or does not achieve agreed-upon performance metrics. Under the economic benefit arrangement, the employer is the owner of the policy, pays the premium and endorses or assigns certain rights to the employee.

The loan arrangement is more complicated as the employee is the owner of the policy and the employer pays the premium. The employee gives an interest back to the employer via a collateral assignment. A collateral assignment limits what the employee can do without the employer’s consent. A collateral assignment example would be for the employer to recover the loans made upon the employee’s death or termination of the buy sell agreement. Lastly, the premium payments by the employer are treated as a loan to the employee.

So, What’s the Bottom Line?

Succession planning for a closely held business presents a unique set of challenges not seen in businesses with multiple owners…challenges that can be offset using a one-way buy-sell agreement funded by permanent life insurance. The beauty of the one-way buy-sell agreement is the owner’s flexibility to retain control of the business and income from it right through to the end of his or her life.

The buy-sell is a very tax-efficient buy-sell strategy and is a great tool for maintaining long-term control. The key employee or family member becomes even more tied to the business with a magnified interest in its success, giving much more incentive for getting involved for the long term.

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One Way Buy Sell Agreement
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