Buy-sell arrangements among entity owners are generally designed either as a “cross purchase” or “corporate redemption” agreement. There are tax and non-tax advantages and disadvantages to each design. The principal benefit of a cross purchase arrangement is that the purchasing owner gets a stepped up basis in the stock acquired from the deceased owner equal to the purchase price (compared to “disappearing basis” in a corporate redemption arrangement). In a cross purchase arrangement every stockholder owns a policy on the life of every other stockholder. Consequently, the number of life insurance policies required in a cross purchase arrangement expands exponentially if the number of stockholder-insureds exceeds two stockholders; this can be very cumbersome from an administration standpoint.
A corporate redemption arrangement in “more than two stockholders” situations is much simpler – the corporation is the owner and beneficiary of a single policy on each stockholder and the corporation uses the insurance proceeds from the policy it owns on the deceased stockholder to purchase/redeem the deceased stockholder’s stock.
In addition to the loss of a stepped up basis, a principal disadvantage in the past to a corporate redemption arrangement is that the insurance proceeds received by the corporation were subject to the corporate alternative minimum tax (“AMT”). The new tax law repeals the corporate AMT, thereby removing this significant disadvantage to corporate redemption plans. Corporate redemption designs may be more widely used in the future, particularly in situations where the failure to obtain a stepped up basis in the deceased owner’s stock is not considered significant. Any client wanting to convert an existing cross-purchase plan to a corporate redemption plan should consult with their tax advisors first to determine if that can be done without negative income tax consequences and without running afoul of the “transfer for value” rules that would subject future insurance death proceeds to income tax.