This article reviews the factors to consider when choosing a cross purchase buy sell agreement and determining a funding vehicle.

 

Under a cross purchase buy sell arrangement the surviving owners are generally obligated to buy the interest of  the deceased owner, and the executor of the deceased owner is obligated to sell.

 

The cross purchase agreement is often less complex because it requires fewer corporate formalities than an entity arrangement.

 

At the first death the surviving business owners purchase the interest from the deceased owner's estate based on the provision and price agreed upon in the agreement.

 

The primary advantage in selecting this method is the increase in basis for survivors.  Avoiding alternative minimum tax (AMT) is also an advantage to cross purchase arrangements.  However, AMT is no longer a concern for qualifying small businesses after the Tax Relief Act of 1997.  The number of policies necessary to fund a cross purchase arrangement using life insurance can be overwhelming for corporations with more than four shareholders.

 

A buy sell agreement is of little value unless it is properly funded.  Funding pertains to how the promises under the agreement will be financed.  The basic methods of funding the agreement include:

The one disadvantage of cross purchase agreements occurs when the business has many owners.  In that situation, because life insurance contracts are all owned on the other owners, many contracts could be required.  A trust could be established to own the contracts.

 

The cross purchase arrangement may minimize future income tax liability by providing surviving owners with an increase in basis.  In addition, a funded buy sell provides the liquidity at the right time and prevents the sale or transfer of the business to unwanted third parties, promotes smooth transition in control, establishes the terms and means for a buy out and eliminates disputes among owners.