After you die, who will own your business?
If you do nothing before you die, your business will pass as part of your estate, probably to your spouse. Is this what you want? More importantly, is this what your spouse wants? Would your spouse rather die? Would your spouse rather have cash? Does your spouse get along with your partner(s) or co-owners? There are many ways to accomplish what you want and I will discuss a few of them.
My advice would be to enter into a “Buy Sell Agreement” with your business partners, or if there are none, a valued employee or even a competitor. Buy sell agreements typically require an owner to first offer his interest back to the business or other owners if he dies, he wishes to sell it or he is no longer employed there. With such an agreement you can provide who will buy your business and for how much. That way, your spouse ends up with cash, and a person who wants and knows the business ends up with the business. Life insurance can be purchased to provide the cash needed to make the purchase. Make sure the buyer is the beneficiary. Another advantage of such agreements is that they keep ownership of the business in the family, so to speak.
There are two major types of buy-sell agreements, a “redemption agreement,” and a “cross-purchase agreement,” Under a redemption agreement, the business that is the expected purchaser owns and is beneficiary of a life insurance policy covering each shareholder. Under a cross-purchase agreement, each shareholder owns and is beneficiary of a policy on each of the other shareholders
There are a number of tax considerations in using buy sell agreements. With a cross purchase agreement, the remaining owners purchase the stock with untaxed insurance proceeds, which establishes their basis in the stock for future sale purposes. Under a corporate redemption agreement, a corporation that uses key man life insurance to fund its redemption of stock there is a definite risk of the alternative minimum tax.
I favor a hybrid buy sell agreement, often called a “wait and see” buy sell agreement. It lets the owners wait until an owner’s death or other sale to decide whether the business or the owners buy the stock. Such an agreement allows the parties to choose the best alternative at the time.