Income tax savings. (Entrepreneur's Notebook).

A major benefit of a cross-purchase buy-sell is that each of the remaining co-owners receives an increase in his or her basis in the company as a result of the purchase of the withdrawing co-owner's interest. Since this does not occur in the redemption situation, the cross-purchase buy-sell can save significant income tax in the event the business is sold in the future.

The types of triggering events that should be considered by owners for inclusion in a buy-sell agreement are: death of a co-owner, total or partial disability of the co-owner (he or she is no longer able to function in the business as before the disability), and the withdrawal or retirement of the co-owner.

Each of these buy-out situations, except for withdrawal or retirement, can be paid through the purchase of life insurance or disability buy-out insurance. If no insurance is purchased or if the insurance proceeds are less than the purchase price, the agreement should provide for an installment payment of the balance of the price, with a stated interest rate.

Too often, even when a buy-sell agreement has been put in place, the co-owners file it in a desk drawer and don't look at it again until a triggering event has occurred, often many years after it was first drafted. This results in an agreement that does not reflect the current ownership of the business. Some of the original co-owners may have left the company or new co-owners may have joined the enterprise. It is therefore important to periodically review the buy-sell agreement and ensure that it reflects the current circumstance and desires of the business and its co-owners.

The most frequent and devastating problem in an out-of-date buy-sell agreement is a purchase price that does not reflect the current value of the business. Think of the impact of you or your estate being forced to sell your interest in your business at a value that is 10 or 15 years old. While the remaining co-owners would be ecstatic, the withdrawing co-owner, his or her estate, spouse or children, would be left with a significantly reduced value for their interest in the business. One way to avoid this problem is to build a formula into the agreement that calculates the value of the business based on objective information, such as gross revenues, profits, book value, or a valuation by an independent third-party appraiser.

Jeffrey Lewis is a partner with the law firm of Reish Luftman McDaniel & Reicher in West Los Angeles. He can be reached at.

Entrepreneur's Notebook is a regular column contributed by EC2, The Annenberg Incubator Project, a center for multimedia and electronic communications at the University of Southern California. Contact James Klein at [phone] with feedback and topic suggestions.