The problem is, when a business owner dies, the business often can die as well…not because anything wrong has been done but because nothing has been done! At death (or disability), no asset tends to deteriorate as quickly or as totally as a business unless proper planning has been done in advance.
In order to guarantee a buyer for the interest in a business (particularly a minority interest which may be of very little value to one’s heirs), consideration should be given to a written lifetime agreement between the business owners as to how to dispose of the business. Without a written agreement, there can be conflicts among the remaining owners and the decedent’s family sometimes resulting in litigation; delays in settling the decedent’s estate; loss of customers and decrease in business value; and possible liquidation of the business which often results in less than full value.
There are different types of business continuation plans to be considered so consultation with an attorney, CPA and other financial advisors is critical.
Executing a business continuation plan is just the first step. What are the various ways to fund the agreement? Generally speaking, there are four ways to fund a buy-sell agreement. They are using cash on hand, borrowing, making installment payments, and through life and/or disability insurance. If cash is used, how much cash will be required and will it be available when needed? What will happen if the cash is unavailable due to an unforeseen situation? Will after-tax dollars need to be kept on hand to finance the purchase? Will a higher alternative rate of return have to be sacrificed in order to keep adequate cash on hand? What will be the true cost of borrowing over time?
Buy-sell agreements are frequently funded with life insurance. Changes in tax law as it applies to a business make it imperative to work with a qualified advisor team to insure the most favorable tax treatment. An important example, under the provisions of Internal Revenue Code Sec. 101(j), death proceeds from a life insurance policy owned by an employer on the life of an employee are generally includable in income, unless certain requirements are met. If these regulatory requirements are met, the proceeds can be received income-tax free. State or local laws may vary. Professional legal and tax guidance is strongly recommended.
Business owners will often use life insurance to protect their company from many of the potential problems which may otherwise damage or destroy what has taken years to build. Premiums are usually small compared to the potential death benefit. Also, if policies are used which build cash values, they can be shown as business assets on the balance sheet, contributing to the value of the business and potentially to its borrowing power. Borrowing against cash values may also be a lifesaving source in times of financial crisis.
Another often use business purpose for life insurance is insuring a Key Employee. Company owns the policy. Company pays the premiums. After death, the company collects the policy proceeds which can be used for a variety of purposes from purchasing stock from the decedent’s estate if he/she were a shareholder, funding salary continuation payments to surviving spouse, recruiting, and training a new employee, paying any necessary bills and strengthening the credit position of the business, funding expansion of the business, or simply adding income-tax free monies to corporate surplus.
Businesses often use life insurance as an additional perk for their employees through salary continuation programs or executive bonus plans for selected employees. There are many designs that could be implemented to benefit/reward selected employees as well as keep these employees tied closer to the business.
Let Coomes Insurance & Financial Services, LLC help you with your business continuation and key employee strategies. We will work hand in hand with your attorney, CPA and any other advisors to insure you get the best planning possible to protect your business dreams.