Business Continuation for More Than Two Owners – Second in a Series

In the previous article, I cited that an “Entity Purchase,” one in which, essentially, the business buys out the deceased shareholder’s beneficiary, presumably the spouse.  While this arrangement may seem logical, it is the least efficient from a tax-perspective.  This is because the remaining shareholders do not get a “stepped-up” tax basis on the newly acquired shares and wind up paying the maximum in capital gains taxes once they sell their share of the business.  What should they do?  Can they conveniently reduce their tax burden?  Some intrepid life insurance agents have suggested that the owners purchase multiple life insurance policies:  the formula for this is (the number of business owners – 1) x the number of business owners).  So, if there are three business owners, they should purchase a total of six policies ((3 – 1) x3)).  Here’s a better way that accomplishes the following:

1.  Simplicity.  Three business owners;  three life insurance policies.

2.  Stepped-Up Tax Basis.  Your capital gains taxes are minimized.

The solution is for a trust to be both owner and beneficiary of all the policies.  This way, when one of the business owners passes away, the trust receives the proceeds and buys out the deceased shareholder’s beneficiary.  Because of the trust arrangement, the remaining shareholders receive a stepped-up tax basis, and their capital gains taxes are held to a minimum.  A word of caution:  make sure that you get an attorney who has written these kinds of  trusts before.  You’ll save yourself a great deal of trouble by doing a bit of research first!

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