In a closely-held corporation where there are a few shareholders, heirs of a shareholder who dies face a number of problems if no plan is in place.
Need for Income
Dividends are sums of money paid on a regular basis by a corporation to shareholders from the profits of the business. In a closely-held corporation, the heirs of a stockholder who has died may need income which will come in the form of dividends from the corporation. Conflict can occur when the need for this income clashes with the surviving shareholders’ salary expectations.
If most of the estate is in the form of stock in the corporation, without other means to pay estate taxes and other administrative costs, some of the stock may need to be sold in order to free up sufficient liquidity in the deceased shareholder’s estate. This can significantly decrease the overall value of the estate.
If there is not a market for the closely-held stock, if the estate needs to liquefy some of the stocks in order to pay for estate taxes, administrative costs, or income for the heirs, problems can arise. Ultimately, the best and most sensible buyers for the deceased shareholder’s stock are the surviving shareholders.
Without advanced planning, many heirs can find themselves with one or more of these problems. In addition, the surviving shareholders may find themselves in a position of bidding with outside buyers who wish to acquire an interest in an already established, successful business. If an advance plan is in place, many of these problems can be avoided.
The Solution with Life Insurance
With many closely-held corporations, the best answer is often for the remaining surviving shareholders to purchase the deceased shareholder’s interest for a fair price to both the heirs and the surviving shareholders. In order to do this without leaving the surviving shareholders scrambling to scrape together the cash needed to complete the purchase, an insured stock redemption buy-sell plan should be in place.
With advanced planning, an insured stock redemption buy-sell plan can accomplish the following:
- The business problems associated with either active or inactive heirs are avoided. With an insured stock redemption buy-sell plan, the surviving shareholders have the cash to pay the heirs for their portion of the stock.
- The commitment for the corporation to buy the deceased shareholder’s stock and the sale of those stock from the heirs is agreed upon in advance.
- Instead of waiting for a buyer to become available at a price agreeable to both buyer and the deceased shareholder’s estate, funds are available exactly when needed at the shareholder’s death.
- For federal estate tax purposes, the value of the business interest may be fixed.
- A full and fair cash price for the business are guaranteed to the deceased shareholder’s heirs.
- The deceased estate shareholder’s estate is promptly settled with the cash that becomes immediately available.
Funding a Buy-Sell Plan
A stock redemption buy-sell plan can be funded in four different ways:
- Cash Method – If there is accumulated cash sufficient to purchase the stock at the shareholder’s death, the corporation could purchase the stock. However, it may take many years to save the necessary funds for the purchase, while the full cash amount may be needed in a few short months. In addition, accumulated earnings may cause tax problems.
- Installment Method – After a shareholder’s death, installments may be made for the purchase price. However, this may mean a drain on the business profits for months or years. Additionally, the surviving heirs are now dependent on future business performance after the shareholder’s death.
- Loan Method – In addition to the drain on future profits from a monthly installment payment, interest on the loan must also be paid. This increases the overall price of a stock and decreases future profits.
- Insured Method – Life insurance is the only guarantee that there is sufficient cash needed to complete the sale and is available exactly when needed. The value of the corporation must be accurately valued for this option to work. This guarantee is also based on the continued ability of the insurer to pay the claims.
Estate Planning Considerations
Federal estate tax rates range from 18% to 40% of the taxable value of an estate. However, with advanced planning, this amount can be eliminated with an estate and gift tax unified credit. A certain portion of an estate may be transferred or gifted annually. A value of the transferred property determines the amount of taxes due to the federal government. However, once this value is determined, it is reduced by an estate and gift tax unified credit which can eliminate the amount of federal estate taxes to zero.
With the complexity of federal estate taxes, many shareholders who are interested in a corporate insured stock redemption buy-sell plan turn to financial advisors. A decision that affects not only a stockholder but family, heirs and business associates should be discussed with a knowledgeable and expert financial advisor or corporate attorney.
Leaving heirs with a plan in place allows for family and loved ones to focus on other matters rather than dealing with the buying and selling of stocks that may affect the future income and lifestyle of a family. Having a corporate insured stock redemption buy-sell plan in place is beneficial for not only the heirs of a stockholder but for the business as well.