Corporate Resolution Redemption - PDF

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					                   Stock Redemption
             Arrangement for Closely
                   Held Corporations
                                                                            “A successful business has a
                                                                            business succession strategy.”

We offer you this concept piece to help you understand how life insurance can be used
to help provide funds for business continuation arrangements. This material contains
references to concepts that have legal, accounting and tax implications. It is not
intended as legal, accounting or tax advice. Consult your own attorney and/or tax
advisor for advice regarding your particular situation. Accordingly, any information in this
document cannot be used by any taxpayer for purposes of avoiding penalties under the
Internal Revenue Code.

Life insurance is issued by The Prudential Insurance Company of America, Newark, NJ,
and its affiliates. All are Prudential Financial companies and each is solely responsible
for its own financial condition and contractual obligations. Like most Insurance policies,
our policies contain exclusions, limitations, reductions of benefits and terms for keeping
them in force. Your licensed financial professional can provide you with costs and
complete details.

      Not insured by FDIC or any Federal Government Agency. May Lose Value.
            Not a Deposit of or Guaranteed by Any Bank or Bank Affiliate.

Prudential, Prudential Financial, the Rock logo, and the Rock Prudential logo are registered service marks of The Prudential
Insurance Company of America and its affiliates.


IFS-A012896 Ed. 10/08 Exp. 12/10
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 Stock Redemption Arrangement                                                      Page 2




Do you identify with the following?
You are a business owner who:
♦ Has spent many long hours working in and creating value in your business and it is
  either one of the major assets or the major asset in your estate.
♦ Would like to create a ready market for the sale of your shares at your death.

♦ Wants to see that the business remains in the hands of just the surviving
  shareholders.

♦ Sees the need to establish an estate value for your business interest in order to
  reduce the potential for IRS disputes.

♦ Wants to be certain funds will be available to help with the buyout of a deceased or
  departing shareholder’s interest.




If so, you may want to consider establishing a stock
redemption buy-sell arrangement funded with life
insurance. A stock redemption buy-sell arragement is:
♦ A contract agreed to by the corporation and shareholders requiring the corporation
  to purchase the interest of a shareholder under specified terms and conditions.

♦ An arrangement that, when funded with life insurance, helps ensure that cash will be
  available to help with the buyout.
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    Stock Redemption Arrangement                                                  Page 3




            Stock Redemption Buy-Sell Arrangement
                                                2. Premiums
                                                                      Insurance
                        Corporation
                                                                      Company
                                               3. Policy Proceeds

    1. Agreement                                  1. Agreement

                    4. Cash         5. Stock
    Shareholder                                       Shareholder
         A                                                 B

                          Estate of
                          Deceased
                           Owner




1. The corporation enters into a stock redemption agreement with each shareholder,
   obligating the business to purchase the deceased shareholder’s stock in the
   corporation and obligating the decedent’s estate to sell.

2. The corporation purchases life insurance protection on the life of each shareholder
   equal to at least the value of the shareholder’s interest. The corporation is the
   owner, premium payer, and beneficiary of each policy. You should consult your legal
   counsel to determine whether notice and consent under IRC § 101(j) is required
   before the policies are issued to receive tax-favored treatment. 1

3. At the death of a shareholder, the corporation collects the life insurance policy
   proceeds from the insurance company.

4. The corporation pays the agreed upon amount, determined by the terms of the stock
   redemption agreement, to the shareholder’s estate.

5. The owner’s estate releases the partnership or LLC interest to the business.


1
  Life insurance death proceeds are generally received income tax-free [IRC § 101(a)].
For employer-owned contracts issued after August 17, 2006, death proceeds will be
subject to income tax. However, where specific employee notice and consent
requirements are met, and certain exceptions apply, death proceeds can be received
income tax-free [IRC § 101(j)].
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    Stock Redemption Arrangement                                                Page 4




Benefits to the Departing Shareholder or Heirs:
♦ If properly drafted, implemented, and maintained, the arrangement helps to establish
  the business value for estate tax purposes.

♦ It provides a ready market for the sale of the business interest.

♦ It ensures that cash to help pay estate taxes and/or to meet family needs will be
  available.

♦ The shareholder’s heirs are relieved of further corporate responsibilities.

♦ Where life insurance is used to fund the buyout, the heirs of the deceased
  shareholder immediately receive cash, avoiding delays and potential liquidation
  losses and are no longer dependent on the corporation for their financial security.

Benefits to the Corporation and Remaining
Shareholders:
♦ The corporation receives life insurance proceeds to finance the buyout of the
  deceased shareholder at the exact time when needed.

♦ The corporation continues uninterrupted with the surviving shareholders as owners.

♦ A stock redemption agreement funded with permanent life insurance can provide
  needed cash to help meet the contractual obligations established by the agreement,
  potentially minimizing the impact on working capital and cash flow.

♦ In contrast to a cross purchase agreement, a stock redemption agreement funded
  with life insurance allows the corporation to purchase just one policy on each owner.

♦ Employees, creditors, and suppliers feel more secure knowing the business has a
  succession arrangement in place.

♦ Where permanent policies are purchased, the cash values of the policies are assets
  of the business that are reflected on the balance sheet and are available for
  business needs. 2

2
 Life insurance policy cash values are accessed through withdrawals and policy loans.
Loans are at interest. Loans and withdrawals cause a reduction in cash values and
death benefits, may affect any guarantees against lapse, and may have tax
consequences.
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    Stock Redemption Arrangement                                                     Page 5




Tax Considerations for the Departing Shareholders or
Heirs:
♦ Qualifying for sale or exchange treatment. Generally, under IRC § 301, stock
  redemptions are treated as corporate distributions (dividends) to shareholders and
  will be taxed as ordinary income to the extent of earnings and profits (E&P).
  However, where shareholder’s qualify the stock redeemed as a “sale or exchange”
  under one of the “safe harbors” found in IRC § 302, the person whose stock is being
  redeemed will receive capital gains treatment. Where a lifetime redemption occurs
  and qualifies for sale or exchange treatment, the difference between the basis of the
  stock and amount realized in the redemption will be taxed as capital gains.

♦ Stock redemptions at death are tax advantageous since the basis of the stock
  receives a “step-up” to fair market value. 3 A sale made quickly after death will
  generally result in no gain, assuming that the sale price is not significantly different
  from the estate value.

♦ Caution for family owned corporations. One of the most common safe harbor
  routes used to achieve capital gains treatment for a stock redemption is a “complete
  termination.” A complete termination occurs whenever the corporation repurchases a
  shareholder’s entire ownership interest if between unrelated shareholders. However,
  where family members are shareholders, additional rules under IRC § 318
  complicate the ability to achieve sales or exchange treatment by attributing to a
  redeeming shareholder stock that is owned by another family member or by various
  entities involving family members. An individual is deemed to own stock directly
  owned by his/her spouse, children, grandchildren, and parents. In addition, “entity
  attribution” can result where stock owned by a partnership, estate, trust, or another
  corporation is attributed to family members as beneficial owners. The constructive
  ownership rules are complicated and their application requires expert legal advice.

     It is important to note that the danger of ordinary income tax treatment exists in
     every buy-sell arrangement structured as a stock redemption in the C corporation
     context where the business involves family members. In contrast, where the
     redemption involves an S corporation that has never been taxed as a C corporation,
     redemption will not result in ordinary income tax, even where there are related family
     members.



3
 Under the Economic Growth and Tax Relief Reconciliation Act of 2001, for the year
2010, the estate tax is repealed. For deaths occurring in that year only, a modified step-
up in basis will be available. This is limited to a step-up of $1.3 million in total for all
beneficiaries and an additional $3 million step-up available for property passing to a
surviving spouse.
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    Stock Redemption Arrangement                                                  Page 6




♦ A properly drafted buy-sell agreement can help establish the value of the business
  interest for estate tax purposes.


Tax Considerations for the Corporation and
Remaining Owners:
♦ For employer-owned life insurance policies issued after August 17, 2006, IRC §
  101(j) provides that death proceeds will be subject to income tax; however, where
  specific employee notice and consent requirements are met and certain safe harbor
  exceptions apply, death proceeds can be received income tax-free. Life insurance
  proceeds are otherwise generally received income tax-free under IRC § 101(a).
  However, if the corporation is a C corporation and subject to corporate alternative
  minimum tax (AMT), policy cash values and death proceeds will affect adjusted
  current earnings. 4 A corporation taxed as an S corporation is not subject to AMT.

♦ Premiums paid for life insurance are not income tax-deductible by the corporation.

♦ Stock redemptions increase the surviving shareholder’s interest in the C corporation
  but do not increase their stock basis.

♦ Although the surviving shareholders have the same proportion of ownership in
  relationship to each other after the redemption as prior to the redemption, care must
  be taken that control of the business is not shifted unintentionally. For example: Dad
  and son own, respectively, 40% and 20% of the corporation, with a key employee
  (unrelated) owning the remaining 40%. Combining their voting power, dad and son
  control the corporation. If dad’s stock were redeemed, the key employee would own
  the majority of the outstanding stock and have control of the business.

♦ Where life insurance is used as a funding vehicle in a C corporation redemption,
  death benefit proceeds received by the C corporation have no effect on a
  shareholder’s basis in the stock. In contrast, in an S corporation, where life
  insurance is used to help fund the stock redemption arrangement, death benefit
  proceeds do increase shareholder basis. Since high basis in an S corporation
  shelters future distributions from income taxation, the use of life insurance can be an
  important tax strategy. The amount of basis increase the surviving shareholders
  receive depends on a number of factors. Consult your legal and tax advisors for a
  complete discussion.

4
  Corporations in their first year or having average annual gross receipts less than $7.5
million for the preceding three-year period (average annual gross receipts of $5 million
for initial qualification) are no longer subject to AMT.
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 Stock Redemption Arrangement                                                        Page 7




♦ If needs and circumstances change, policies can be transferred from the corporation
  to the insured shareholder without creating “transfer-for-value” taxation issues.


                      Recommended Action Plan
   1. Seek the professional advice of your attorney regarding your personal needs and
      objectives for the disposition of your business interest in the corporation.

   2. Meet with your accountant, attorney, and/or professional appraiser to determine
      the value of your business interest.

   3. Determine the appropriate insurance solution.

   4. Have your attorney draft the stock redemption agreement, corporate resolution,
      and other appropriate documents.

   5. Apply for the life insurance to be owned by the corporation and complete all
      medical and underwriting requirements.

   6. Review the buy-sell arrangement with your licensed financial professional,
      attorney, and accountant on a regular basis.

				
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