Presenting a live 90-minute webinar with interactive Q&A Buy-Sell Agreements for Corporations and LLCs: Drafting Stock Redemption, Cross-Purchase and Mixed Agreements Navigating Complex Corporate, Tax, Estate Planning and Insurance Law Issues When Planning for a Business Transition WEDNESDAY, JULY 12, 2017 1pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Brian E. Hammell, Esq., Sullivan & Worcester, Boston Martin B. Robins, Partner, FisherBroyles, Chicago The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.
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Please don t hesitate to reach out after this program Martin B. Robins of FisherBroyles LLP: 847 277 2580 or martin.robins@fisherbroyles.com www.fisherbroyles.com 18
Buy-Sell Agreements for Corporations and LLCs: Tax Issues Brian E. Hammell bhammell@sandw.com (617) 338-2462
Redemption vs. Cross-Purchase Redemption Agreement between entity and its owners Company agrees to purchase shares/interests upon certain triggering events Cross-Purchase Agreement among owners of the entity Other owner(s) agree to purchase shares/interests upon certain triggering events 2017 Sullivan & Worcester LLP 20
Redemption vs. Cross-Purchase Hypothetical Corporation with two shareholders Value of the Company = $2,000,000 Shareholder A's Basis = $10,000 Shareholder B's Basis = $10,000 2017 Sullivan & Worcester LLP 21
Redemption vs. Cross-Purchase Lifetime Transfer Tax Consequences to the Transferor Shareholder A shares purchased for $1,000,000 Gain on transfer = $990,000 Amount realized ($1,000,000) minus basis ($10,000) Capital gain (generally) Federal Income Tax = $198,000 (assuming 20% long-term capital gains rate) 2017 Sullivan & Worcester LLP 22
Redemption vs. Cross-Purchase Lifetime Transfer Tax Consequences to the Remaining Owner upon a future sale Redemption Cross-Purchase Company worth $2,000,000 Company worth $2,000,000 Shareholder B Basis = $10,000 Shareholder B Basis = $1,010,000 Gain = $1,990,000 Gain = $990,000 Tax = $398,000 Tax = $198,000 *Assumes a 20% long-term capital gains rate 2017 Sullivan & Worcester LLP 23
Deemed Dividend in Case of Redemption The above example presumes that the redemption is treated as a sale or exchange under Section 1001 of the Code This is the general result for a complete termination of the retiring owner's interest However, a potential trap exists under Section 302(b) of the Code A redemption payment to a retiring shareholder is treated as a distribution to the retiring shareholder with respect to his or her shares (and not in exchange for the shares) if the redemption does not satisfy any of the Section 302(b) tests (e.g., the retiring shareholder continues to own too many shares, actually or by attribution, after the redemption) Family attribution rules under Section 318 apply 2017 Sullivan & Worcester LLP 24
Deemed Dividend in Case of Redemption Family Attribution Example Father owns 60% of stock in corporation Son owns 30% Mother owns 10% Father's stock is redeemed by the corporation Son and Mother's stock is attributed to Father, thus redemption is not a complete redemption and proceeds may be taxed as a dividend 2017 Sullivan & Worcester LLP 25
Deemed Dividend in Case of Redemption Exception to Family Attribution Rules Family attribution rules do not apply where: Immediately after the distribution, the distributee has no interest in the corporation including an interest as an officer, director or employee, other than an interest as a creditor The distributee does not acquire any such interest other than stock acquired by bequest or inheritance within ten years from the date of such distribution The distributee files an agreement to notify the IRS of any acquisition described above 2017 Sullivan & Worcester LLP 26
Insurance Funded Buy-Sell Agreements Redemption Agreements Entity buys insurance on the lives of its shareholder Entity is the owner and the beneficiary At death, the entity receives life insurance proceeds Proceeds are used to purchase shares/interests of the deceased owner 2017 Sullivan & Worcester LLP 27
Insurance Funded Buy-Sell Agreements Issues Related to Insurance Owned by the Entity Premiums are non-deductible Section 264(a)(1) Proceeds are income tax free Section 101(a)(1) Exception for a C Corporation which is subject to the Alternative Minimum Tax Proceeds are not includable in the Estate of the Decedent Treas. Reg. 20.2042-1(c)(6) 2017 Sullivan & Worcester LLP 28
Insurance Funded Buy-Sell Agreements Issues Related to Insurance Owned by the Entity COLI Best Practices Act Section 101(j) Applies to employer-owned polices issued after August 17, 2006 and previously issued policies in the event of material change IRS Form 8925: Provides notice of (a) number of policies held and (b) the total face amount of said policies Death benefits of employer-owned policies will generally not be taxable if: Employer gives employee written NOTICE and gets written CONSENT from employee before policy is issued AND Insured employee fits SPECIFIED EXCEPTIONS OR Death benefits fit SPECIFIED EXCEPTIONS 2017 Sullivan & Worcester LLP 29
Insurance Funded Buy-Sell Agreements Cross-Purchase Agreement Each owner purchases life insurance on the lives of each other owner Shareholders/members are owners and beneficiaries of the policy At death, surviving owner(s) receive life insurance proceeds from policy insuring life of deceased owner Surviving owners buy shares/interests from estate of deceased shareholder 2017 Sullivan & Worcester LLP 30
Insurance Funded Buy-Sell Agreements Cross-Purchase Agreement Premiums must be paid by the owners and not the entity Potential equity problem due to cost differences in underwriting Payments from company are regarded as taxable compensation or distribution of S corporation profits Split dollar still an option to consider Premiums are non-deductible Section 264 Proceeds are income tax free Purchase of interests increases cost basis of surviving owners, reducing capital gains at time of future sale 2017 Sullivan & Worcester LLP 31
Insurance Funded Buy-Sell Agreements Transfer at Death Tax Consequences to the Estate Assume company had $1,000,000 life insurance policy Shareholder A Shares purchased for $1,000,000 No capital gain due to step up to fair market value at death Section 1014 2017 Sullivan & Worcester LLP 32
Insurance Funded Buy-Sell Agreements Lifetime Transfer Tax Consequences to the Remaining Owner upon a future sale Redemption Cross-Purchase Company worth $2,000,000 Company worth $2,000,000 Shareholder B Basis = $10,000 Shareholder B Basis = $1,010,000 Gain = $1,990,000 Gain = $990,000 Tax = $398,000 Tax = $198,000 *Assumes a 20% long-term capital gains rate 2017 Sullivan & Worcester LLP 33
Insurance Funded Buy-Sell Agreements Transfer for Value Issues Conversions from Redemption to Cross-Purchase Agreements could result in negative income tax consequences Proceeds may be taxable income Section 101 2017 Sullivan & Worcester LLP 34
Fixing the Value of the Estate Special Valuation Rules Section 2703 Buy-Sell Agreement must satisfy the following rules: Be a bona fide business arrangement Section 2703(b)(1) Not be a device to transfer business interest to family members for less than full and adequate consideration Section 2703(b)(2) Be comparable to similar arrangements entered into by unrelated parties bargaining at arm's length Section 2703(b)(3) 2017 Sullivan & Worcester LLP 35
Fixing the Value of the Estate Cannot fix price between family members Bottom Line: Purchase price needs to be Fair Market Value or based upon a formula which approximates Fair Market Value Whipsaw Potential State law will likely declare a sale for less than Fair Market Value to be binding on the parties 2017 Sullivan & Worcester LLP 36
Other Drafting Points Transfer restrictions to avoid adverse tax consequences e.g., prohibit transfers of S corporation stock to ineligible S corporation shareholders Purchase price allocation for S corporations and partnerships Tax indemnification obligations Impact of new partnership audit procedures Deferred compensation arrangements 2017 Sullivan & Worcester LLP 37
Buy-Sell Agreements for Corporations and LLCs: Tax Issues Brian E. Hammell bhammell@sandw.com (617) 338-2462