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September is Life Insurance Awareness Month, and there’s no better time to reflect on life insurance’s crucial role in business succession planning. Life insurance often proves invaluable in buy-sell agreements, particularly for business owners seeking to protect their companies and loved ones in the event of an untimely death.
Recently, the Connelly decision has shed new light on how buy-sell agreements are structured and funded, raising questions about the tax implications of life insurance policies used to fund these agreements. At Attracct Financial Advisors, we believe it’s important to understand the complexities of this ruling and how it might affect your business succession plans.
The Connelly Decision: A Quick Overview
In the Connelly case, the courts examined a buy-sell agreement funded by life insurance, specifically how the agreement was taxed after the death of a business partner. The ruling ultimately found that how the life insurance was structured had unintended tax consequences, potentially exposing the surviving business owners to unexpected liabilities.
This decision has forced many business owners and financial advisors to revisit the details of their buy-sell agreements and ensure they are not inadvertently creating tax exposure by using life insurance in ways that were not originally intended.
Buy-Sell Agreements and Life Insurance
A buy-sell agreement is a legally binding contract between business co-owners that determines what will happen to a business if one of the owners dies, retires, or becomes incapacitated. These agreements are critical in ensuring the continuity of the business and protecting the interests of both the departing owner and the remaining owners.
In many cases, life insurance is used to fund a buy-sell agreement. The policy provides the surviving business partners with the financial means to purchase the deceased partner’s shares, ensuring that the business remains in the hands of the surviving owners and that the deceased partner’s family receives fair compensation.
Types of Buy-Sell Agreements Funded with Life Insurance
There are two main types of buy-sell agreements that can be funded with life insurance:
- Cross-Purchase Agreement – In a cross-purchase agreement, each business owner purchases a life insurance policy on the other owners. When one owner dies, the surviving owners use the death benefit from the life insurance policy to buy the deceased owner’s share of the business.
- Entity-Purchase Agreement – In an entity-purchase agreement, also known as a stock redemption plan, the business purchases a life insurance policy for each owner. When an owner dies, the business uses the death benefit to buy back the deceased owner’s shares, which are then redistributed to the surviving owners.
Impact of the Connelly Decision on Buy-Sell Agreements
The Connelly decision has clarified that how buy-sell agreements are structured can have unintended tax consequences. Specifically, if the life insurance is not set up correctly, the death benefit could be taxed or create additional liabilities for the surviving business owners.
In light of this ruling, business owners should review their buy-sell agreements and the way life insurance is being used to fund them. It’s crucial to ensure that the agreements are structured to avoid triggering unintended tax consequences. Working closely with a financial advisor and an experienced attorney can help ensure that your buy-sell agreement continues to protect your business and your family without creating unnecessary risks.
Why Life Insurance is Still Key in Buy-Sell Agreements
Despite the concerns raised by the Connelly decision, life insurance remains one of the most effective ways to fund a buy-sell agreement. It provides a tax-free death benefit that can be used to ensure the smooth transition of business ownership, protects the business from financial disruption, and provides liquidity to compensate the deceased owner’s heirs.
With proper planning, life insurance can be structured to avoid the issues highlighted in the Connelly case. Working with a knowledgeable advisor ensures that your buy-sell agreement is airtight and that your business succession plan is rock solid.
Life Insurance Awareness Month: Time to Reevaluate Your Strategy
As we observe Life Insurance Awareness Month, now is the ideal time to reassess your buy-sell agreements and the role life insurance plays in your business succession plans. Ensuring that your policies are structured correctly can protect your business and loved ones from unintended tax consequences and provide the peace of mind that comes with a solid financial plan.
For educational purposes only – not to be relied upon as financial, tax, or legal advice.
Contact Us for a Complimentary Consultation
Have questions about how the Connelly decision might affect your buy-sell agreement or life insurance strategy? Contact us at Attracct Financial Advisors for a complimentary consultation. We’re here to help you navigate these complexities and protect your business and family.
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