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Structuring a Buy-Sell Agreement

Structuring a Buy-Sell Agreement

Buy-sell agreements can be structured to meet the needs of both the business and the owners, taking into consideration tax implications and individual goals for the transfer of the business. In its simplest form, a buy-sell is generally structured in one of the following ways. Combinations of these are also possible.

In order for a buy-sell agreement to be effective in setting the value for estate tax purposes, the agreement must:

Funding a Buy-Sell Agreement

The terms of the buy-sell agreement should specify how the purchasing party will pay for the business interest.

Savings Fund

Since death and disability, and occasionally an owner's withdrawal, can occur without notice, planning to save for these events can be impractical. Attempts to save for these events cannot assure that sufficient funds will be available when needed.


The loss of an owner of a closely held business can have a devastating impact on the stability and future success of the business. At the death or disability of an owner, when cash is needed most, banks and loan institutions may be reluctant to lend money to the company or co-owners. Credit standings, ability to borrow, and the cost of borrowing in the future are unknown, making borrowing impractical and possibly expensive.

Installment Sales

Installment sales are often part of a buy-sell agreement and may be used to pay all or some of the purchase price. Installment sales require payment of principal and interest from current earnings and force the departing owner or heirs to rely upon the future success of the business in order to receive payments.

Used alone, installment sales place a substantial burden on all the parties. Used in conjunction with insurance funding, installment sale provisions provide a method of completing the purchase when existing life or disability buyout insurance is inadequate.

Life Insurance Funding
  • Insurance creates a cost-effective method of providing for the death or disability of an owner.
  • Life insurance produces an immediate death benefit that is generally received income tax free at the precise time it is needed.
  • If permanent life insurance (i.e., that which provides a cash value) is used, the life insurance policy may serve double duty, providing a death benefit and also a cash value fund that accumulates on an income tax-deferred basis and can be accessed via loans and/or withdrawals.
  • Policy cash value, if any, may be available to provide some of the funds necessary to purchase an owner's interest at retirement or withdrawal. (Death benefit amount will be reduced if cash value is withdrawn from policy.)

Life insurance can transfer the risk of premature death from the co-owners or business to the insurance company.

To ensure the income tax-free nature of the death benefit for certain business-owned life insurance policies, it is necessary to comply with new Internal Revenue Code Section 101(j) for policies issued after August 17, 2006.

These rules require that the insured/employee receive notice of, and consent to, the issuance of a life insurance policy where the business/employer is the owner and beneficiary of the policy and will continue to be the beneficiary after the insured leaves the business.

For more information on these rules and additional reporting requirements, please contact your tax advisor.

Advantages of Life Insurance
  • Complete financing is guaranteed from the beginning.
  • Proceeds may be free from income tax.
  • Cash values can be used for a buyout due to retirement or disability. (Death benefit amount will be reduced if cash is withdrawn from policy.)
  • It is generally the most economical method.
  • Credit position is strengthened.

Western & Southern Life does not give tax advice. Please contact your tax advisor for information that applies to your situation.


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Last Updated: 12/14/2017