A trusteed cross-purchase buy-sell arrangement is a legal agreement between a third party and the stockholders that provides for the planned disposition of the stock at an agreed upon price in the event of a death, disability, or retirement. The trustee acts to carry out the obligations of the stockholders under the buy-sell agreement.
A Trusteed Cross-Purchase Buy-Sell Arrangement and Life Insurance Funding
Funding a cross-purchase buy-sell arrangement with life insurance requires each shareholder to own a policy on every other shareholder. For example, this means that six policies would be required to fund a cross-purchase buy-sell arrangement involving three shareholders. The formula for calculating the required number of policies is N x (N-1), where N equals the number of shareholders. The need for so many policies is a major disadvantage of the cross-purchase approach whenever there are more than two or three shareholders involved.
In a trusteed arrangement, the shareholders establish a revocable trust naming an impartial third party as trustee. The trustee is the owner and beneficiary of one policy on the life of each shareholder. This reduces the number of policies needed. On the death of a shareholder, the trustee is obligated to collect the insurance proceeds and distribute them to the surviving shareholders as beneficiaries of the revocable trust. The shareholders then have the funds to purchase the stock of the deceased shareholder, required by a separate cross-purchase buy-sell agreement.
The agreement may provide that the trustee collects the premiums from the insureds. Each shareholder insured would contribute funds to the trust, which would allow the trustee to pay the premiums as they come due. Alternatively, the business can pay the premiums for each shareholder’s policy and treat those payments as bonuses (tax-deductible, assuming no reasonable compensation problems exist). The premiums on each policy are treated as income to the shareholders.
There are disadvantages to consider when using a trusteed cross-purchase arrangement. Possible transfer-for-value1 issues may exist. For example, assume A, B, C, and D are equal stockholders in a corporation with a funded trusteed cross-purchase agreement. Under the arrangement, each stockholder is the beneficial owner of a one-third interest in the policies insuring the other three stockholders. Now assume that A dies. A prohibited transfer-for-value could occur if A’s proportional interest in the outstanding policies insuring B, C, and D pass to the surviving stockholders upon A’s death. At the next death, a portion or all of the death benefit may now be income taxable unless an exception to the transfer-for-value rule is found.
- 1 Certain transfers of life insurance contracts may jeopardize the income tax free payment of the death proceeds (above basis in the contract). You should always consult your tax and legal advisors prior to making any changes to ensure that the transfer is either not a transfer-for-value or meets one of the exceptions to the transfer-for-value rule and thus the death benefit will still be received income tax free.
Trusteed Cross-Purchase Arrangement
How it Works During Life
How it Works Upon Death
