Buy-sell agreements in focus with Court decision and TCJA expiration

Business owner clients seeking to use the shrinking estate-tax window to pass down closely held shares may need to think through new or updated buy-sell agreements.

The potential expiration of many provisions of the Tax Cuts and Jobs Act of 2017 at the end of next year means that the minimum size of an estate subject to taxes of up to 40% at death could drop down by a half from their current levels of $13.61 million for individuals and $27.22 million for joint filers. Financial advisors, tax professionals and their clients are therefore considering a lot of estate-planning strategies that include trusts or life insurance policies.

For business owners trying to remove some assets from their estates while ensuring an orderly succession in the event of death, disability, retirement, divorces or other challenges, the buy-sell agreements are "not a direct correlation" to the possible expiration but an important factor ahead of the sunset date, said Dawn Jinsky, a certified financial planner and certified public accountant who is the leader of estate and business transition planning with Southfield, Michigan-based registered investment advisory firm Plante Moran Wealth Management. 

Those discussions are also coming after a Supreme Court decision this past summer added more valuation questions about the impact of any life insurance proceeds to closely held shares that are part of an estate, she noted.

"Many people are choosing to gift closely held stock because of the decreasing exemptions, and if you are doing that, you also need to look at a buy-sell agreement," Jinsky said in an interview. "It's become an ancillary discussion that has to happen."

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With taxes that can "add up quickly" for larger estates and any number of scenarios that may leave the business in the hands of the wrong people in the eyes of one or more current owners, the agreements represent another area in which "failing to plan is planning to fail," she added.

In general, the business owners must choose between three kinds of buy-sell agreements: an entity-purchase agreement setting up the business itself to buy a deceased partner's stock; a cross-purchase deal that provides for the other holders to pick up the holdings; or a hybrid one that gives the business the first right of refusal, according to Jinsky. The Supreme Court decision in Connelly v. Internal Revenue Service brought more concerns around potential taxes on life insurance proceeds in the first and third options among businesses such as many RIAs themselves and a great number of their clients, experts have noted.

"While the Court admitted that the dispute in the Connelly case is narrow, with its result 'a consequence of how the Connelly brothers chose to structure their agreement,' the decision may have far-reaching implications for closely held businesses," Levenfeld Pearlstein attorneys Suzanne Shier and Robert Garner wrote in a blog on the firm's website last month. "If your company has a redemption agreement funded by life insurance at the company level, it is essential to understand the implications of those agreements from an estate tax perspective."

Describing those kinds of scenarios or posing the concern of what may happen if, say, one partner in the business goes through a divorce or one of the children of an owner dies, can help advisors and tax professionals convince clients to start the conversation about a buy-sell agreement. 

Those documents enable the businesses to establish "all the parameters" for any unforeseen events, with the method for valuation looming as "one of the most critical of those decisions," Jinsky said. So-called tagalong rights provide certainty that heirs will get "some kind of true fair-market value" for their holdings and avoid scrutiny by the IRS or any state authorities noticing a disparity between the sales price of a business and the size of their estate, she noted. The agreements spell out the process and formula for those valuations.

Otherwise, the owners may run into a situation in which "'my business partner and her family owe a huge estate tax liability but didn't get the corresponding proceeds,'" Jinsky said.

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Clients can work out any other issues that could come up through crafting the buy-sell agreement as well, she added.

"Death, disability and retirement are the three key ones that you establish, but then there are some other ones that can be put into the buy-sell agreement," she said. "A buy-sell can be as complicated or simplified as the situation warrants. If you've seen one buy-sell, you've seen one buy-sell. It really varies based on who are the owners and what are they looking to accomplish."