Student Question of the Week: Buy-Sell Agreements – Funds for the Deceased’s Family

Student Question from Johnathon
Course:  Income Tax Planning

Student Question:

Good Afternoon: I am confused by the answer for the question below. It indicates that one of the correct responses is that the family members of the deceased will receive cash from the life insurance policies. The way I understand the Buy-Sell Agreement process is that the company or the surviving partners receive the proceeds of the life insurance and not the family of the deceased. Can you explain why they would receive a payout from the buy-sell insurance policies?

Question 16: Two of your clients, who had come to you for advice about setting up a business to haul hazardous materials, have now come to you to discuss a Buy-Sell Agreement funded by life insurance policies. You advise them this may be a good alternative for which of the following reasons?

1. A Buy-Sell Agreement funded with life insurance will quickly provide cash to the family of the deceased shareholder.
2. Life insurance funding will mean the corporation will not have to use other corporate funds or incur further debt to pay for the buyout of the deceased shareholder’s shares.
3. A Buy-Sell Agreement funded with life insurance will provide liquidity when one of the shareholders dies.
4. When stock is purchased in accordance with a Buy-Sell Agreement, all surviving shareholders will always get a full step up in the tax basis of all of their shares.

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Instructor Response:

Great to hear from you, Johnathon.  Good question here.  So you’re correct that the surviving partners or the business itself will receive the funds, but they receive the funds so that they can purchase the shares of the deceased owner from the deceased partner’s family.  So, the surviving partners or the business will receive the benefits of the life insurance policy and then they use that money to buy the deceased owner’s shares from the family/beneficiaries.  Therefore, while not directly, the family would indeed receive cash.  Therefore, the correct answer on this question would be 1, 2, and 3.

Thanks for the question!