Estate Planning Considerations

A properly drafted cross-purchase agreement may help to establish the value of a deceased owner's business interest for estate tax purposes if specific requirements are met. The key is for the agreement to meet IRS guidelines and approximate the fair market value of the business interest on the date the agreement is made. Under IRC Sec. 2703, an agreement entered into after October 8, 1990, can establish the value of a closely held business if (1) it is a bona fide arrangement, (2) it is not a device to transfer the business to family members for less than full and adequate consideration, and (3) it has terms comparable to those of arm's-length transactions.

The accumulated case law has created certain additional rules, which apply even if a particular agreement is not subject to IRC Sec. 2703 (e.g., because it was executed before October 8, 1990): (4) the estate must be obligated to sell at an owner's death, either under a mandatory agreement, or under an option held by the business or the surviving owners; (5) the sale price must be fixed by the agreement, either as a dollar amount or by some formula for determining the price; (6) the agreement must prohibit an individual owner from selling his or her interest during life without first offering it to the business or to the other owners at a specified price; and (7) the price set in the agreement must have been fair and adequate at the time the agreement was made.

Capital Gains for Heirs

Sale of the deceased owner's interest by the executor will have no adverse income tax consequences because of the stepped-up basis provision (through 2009). The deceased owner's original basis is automatically stepped-up to its value for estate tax purposes. Thus, the estate usually realizes no capital gain on the transaction and no income tax is payable.

Stepped-up basis is scheduled to be repealed for one year beginning on January 1, 2010, and then reinstated on January 1, 2011.

A limited step-up is available in year 2010.

Cash Values

The cash values of policies owned by the deceased on the lives of other owners are included in the deceased owner's estate. Large cash value amounts could have a significant impact on the size of the estate and thus on the estate tax payable.

Alternative Minimum Tax

Since the business does not own the policies used in a cross-purchase agreement, there are no potential corporate alternative minimum tax consequences.