Mad Golf Inc., a successful C corporation, has three shareholders: Larry, Brice

Question

Mad Golf Inc., a successful C corporation, has three shareholders: Larry, Brice and Joe. All the shareholders are in their early fifties. The company has a redemption buysell agreement funded with corporateowned life insurance. If a shareholder dies, the company will use the life insurance death benefit that it receives taxfree to redeem the stock of the deceased shareholder. Joe recently attended a financial planning seminar and learned that their redemption structure structure was "all wrong" because because the remaining remaining shareholders shareholders received received no stepup in their stock basis for the amounts paid to the deceased shareholder. He claimed they were "wasting a huge income tax benefit" because it was likely that the surviving two would probably "sell the company and cash in if one of the partners kicked the bucket." Joe is adamant that the agreement be changed to a crosspurchase structure immediately. You have been retained by the company to deal with Joe's demands. How would you advise the shareholders?

Explanation / Answer

Joe is right, the agreement should be changed to a cross purchase structure or a buy-sell agreement should be implemented immediately due to following reasons:

Without a buy-sell agreement, corporations are at the whims of circumstance. If a major shareholder dies, the executor of his estate could now direct the company, or that shareholder's heir, whether it is his wife, brother, son, or friend, could become the owner and direct the company. If that person has views that oppose the other shareholders, the remaining shareholders will be subjected to those views and any potential adverse impact on the company. A buy-sell agreement details what happens in the event of death and other scenarios. For example, the remaining shareholders may have the right to immediately purchase all of the deceased shareholder's shares.

When a small business incorporates, it is automatically a C corporation, also called a regular corporation. Death of a shareholder has no impact on the corporate structure, unlike a partnership. Transfer of stock or death of an owner does not alter the corporation, which exists perpetually, regardless of owners, until it is dissolved.

The proceeds of life insurance are not taxable income to the corp, although it is possible the corp is subject to AMT. The estate gets a step up in basis on the stock to its fair market value on date of death (which will include the value of the insurance). The corporation can then redeem the stock, the estate/beneficiaries will have little if any gain on the redemption.

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