Cross-Purchase: An Alternative to Entity Agreements

An alternative to an entity agreement is a cross-purchase buy-sell agreement. Under a cross- purchase agreement, the surviving owners (rather than the business itself) agree to buy the deceased owner's interest. This arrangement is usually memorialized in a written agreement among the owners.

In recent years, the cross-purchase agreement has often been preferred to the entity agreement because the surviving owners in a cross-purchase receive an increase in the basis of their business interests that will reduce their gain upon a later sale of the interest. The survivors receive no such increase in basis when the entity purchases a decedent's interest.

Also, in the cross-purchase agreement, there is no potential for a corporate alternative minimum tax (AMT) liability as there is in an entity agreement. (Note: Recall that the AMT has been repealed for "small corporations" after 1997.)

When the Entity Agreement Is Preferred

While there are no fixed rules, here are some of the situations where an entity or stock redemption agreement may be preferable to a cross-purchase agreement:

• There are a large number of owners. An entity or stock redemption plan means there is one policy for each owner. Under a cross-purchase agreement, each owner would generally own a policy on every other owner.
• There is a wide disparity in the ages of the owners. A cross-purchase agreement would force younger owners to pay high premiums for policies on the lives of older owners.
• The business wants the cash values of the policies to be available as reserve funds, which would not be possible under a cross-purchase agreement. (If the business uses these cash values the death benefit would be reduced and an owner's untimely death could create financial distress, since loans or withdrawals will reduce the death benefit payable, possibly defeating the purpose for which the agreement was intended.)

Funding Options

The insurance professional has two responsibilities when discussing buy-sell agreements:

• establish the need for the agreement, and
• show why insurance products are appropriate for funding the agreement.