A buy-sell agreement is an essential legal framework that dictates the transfer of business ownership interests under specific conditions. It acts as a safeguard, ensuring the continued operation of the business when certain events, commonly known as the "five D’s," take place:

• Death
• Disability
• Divorce
• Departure (whether voluntary or involuntary)
• Disqualification (due to misconduct requiring an owner’s removal)

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The creation of a buy-sell agreement is a complex process that requires careful legal oversight. Engaging an attorney is crucial to ensure that the agreement is comprehensive and in full compliance with applicable laws. Business owners should work closely with legal and financial advisors to tailor the agreement to their specific circumstances.

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Key Types of Buy-Sell Agreements: Entity-Purchase and Cross-Purchase

Buy-sell agreements play a vital role in maintaining business continuity amid unforeseen challenges. The two most common forms of these agreements are entity-purchase and cross-purchase agreements.

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Entity-Purchase Agreement

An entity-purchase agreement, also known as a stock redemption agreement in corporate settings or a liquidation of interest in partnerships, requires the business itself to buy an owner's share at a predetermined price when a triggering event occurs. Life or disability insurance often funds these agreements, with the business owning the policies, paying the premiums, and acting as the beneficiary. The proceeds from the insurance are then used to buy out the departing owner’s interest in the event of death or disability.

This approach is generally straightforward, as the business handles all aspects of the insurance policies. If whole life insurance with cash value is utilized, the policy’s cash value is recorded as a business asset on the balance sheet. However, tax implications may vary depending on the business’s corporate structure, so careful consideration is necessary.

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Cross-Purchase Agreement

In a cross-purchase agreement, each business owner takes out life insurance policies on the other owners, covering their respective ownership stakes. Each owner pays the premiums and is the designated beneficiary. Upon the death of an owner, the insurance proceeds are used to purchase the deceased owner’s share from their estate or family.

While this method is effective for businesses with a few owners, it can become complex if there are many shareholders. In such cases, a trusteed cross-purchase arrangement can be utilized, where a trust manages the insurance policies and the transaction. Upon an owner's death, the trust allocates the deceased owner’s shares to the surviving shareholders. Disability buy-sell insurance can also be added to facilitate ownership transfer in the event of a shareholder's total disability.

Regardless of the agreement's structure—whether entity-purchase, cross-purchase, or trusteed cross-purchase—the tax treatment of premiums and benefits remains the same. Premiums are not tax-deductible, but the benefits are typically received tax-free.

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Ensuring Business Continuity

As a business owner, safeguarding your enterprise against unexpected events like death or disability is crucial. By proactively establishing a well-crafted buy-sell agreement, you can help secure the long-term viability of your business and protect your family’s financial future.

MassMutual has been dedicated to helping individuals secure their financial futures and protect their loved ones since 1851. With a network of over 7,500 financial professionals, we offer support in insurance, investing, retirement planning, estate management, and more. To connect with a MassMutual expert or request a consultation, please contact us, and we’ll arrange for one of our professionals to assist you.

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