Sole proprietorship buy-sell agreements are always cross-purchase plans, since there is no separate business entity in a proprietorship. If the intended buyer is a key employee, the employee would own, pay for and be beneficiary of insurance on the life of the businessowner. Split-dollar can be used if the employee cannot afford to fully fund the plan with life insurance.
Partnership cross-purchase buy-sell agreement
Example: A, B and C are equal partners in a business worth $900,000. Each partner buys $150,000 insurance on the lives of the other two principals. Here's how the plan works if B dies.
At B's death, B's estate receives $300,000. A and C each receive one-half of B's interest in the business and a stepped-up basis in their partnership interests.
Tax treatment (under current tax law)
- Premium payments are considered non-deductible personal expenses.
- Death proceeds are received by the surviving principals income-tax free.
- Proceeds of policies owned by the surviving principals on the deceased's life will not be included in the deceased's estate; cash values of policies owned by the deceased on the other principals' lives will be included in the deceased's estate.
- The surviving principals' interests in the business increase when the death proceeds are used to purchase the business interest from the deceased's estate.
- The deceased's estate receives a step-up in basis for the business interest sold (usually, the new basis is the fair market value at the deceased's death). No capital gain will result if the amount the estate receives for the business equals the fair market value.
- In a sole proprietorship, if a split-dollar funded buy-sell plan is arranged between a key employee and the businessowner's spouse, the policy proceeds will not be included in the deceased's gross estate.
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