Funding a Three-Shareholder Buy-Sell With a Planned Retirement and a Cardiac History

An entity redemption has the corporation buy Alan's 55% interest. Beth and Carlos remain in their 30:15 ratio, so Beth becomes a 66.7% owner and achieves voting control without Carlos buying anything. Only one policy on Alan is needed, the corporation pays premiums, and the corporation receives the death benefit. The weakness is basis: Beth's and Carlos's basis does not increase, so future sale of their stock produces more capital gain. Alan's complete redemption of his 55% can qualify as a sale under IRC Section 302(b)(3) if the family-attribution waiver is filed. A cross-purchase has Beth and Carlos buy Alan's shares directly; each gets a basis step-up equal to the purchase price, but Carlos refuses to buy, so Beth would have to buy all 55% and become an 85% owner. That requires a $2.1 million policy owned by Beth on Alan, plus separate policies if the arrangement expands later. Cross-purchase administration is heavier and does not solve Carlos's liquidity or consent issues. Given Beth's control objective and Carlos's passivity, an entity redemption, or a wait-and-see agreement with an entity redemption first, is the more practical structure; the lost basis step-up is the price of simplicity and control.

Insurance addresses the premature-death risk, not the planned retirement trigger. A three-year term policy on Alan may be rated or declined because of the prior myocardial infarction, stents, and reduced ejection fraction; even if issued, it expires at or before the planned retirement and cannot fund a retirement buyout. The retirement buyout should be funded by a sinking fund or an installment promissory note. Alan's $2.1 million price over three years would require $700,000 per year, and the company has only $600,000 of cash, so a lump-sum payment is unrealistic. Negotiate a five- to seven-year installment payout secured by the stock and possibly corporate assets, with a valuation formula and annual updates. Use insurance only for death before retirement: obtain informal underwriting for $1 million to $2.1 million of term or guaranteed universal life, and if the offer is rated, compare the cost with the sinking fund. The SBA loan must be addressed: the bank should consent to the transfer and release Alan's personal guarantee at closing, perhaps with a 12-month tail; the buy-sell should not trigger a default.

If the corporation redeems Alan's stock, the corporation should own the policy on Alan and be the beneficiary. Premiums are not deductible, and the death benefit is generally received income-tax-free by the corporation, but it does not give Beth a basis step-up. If the parties instead use a cross-purchase, Beth should apply for a new policy as owner and beneficiary with Alan's written consent. Beth must not buy Alan's existing policy: a transfer to a shareholder who is not the insured, a partner, a partnership, or a corporation in which the insured is a shareholder or officer can trigger the transfer-for-value rule, making the death benefit taxable. Beth is a shareholder of the corporation, but she is not the corporation, so the exception does not clearly apply. Also avoid having Alan own the policy and name Beth beneficiary, because the proceeds would be included in Alan's estate and exposed to his creditors. If the corporation pays premiums on a cross-purchase policy, split-dollar or economic-benefit rules may apply. Keep ownership, beneficiary, and premium-payer roles consistent with the agreement.