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Buy-out of sole proprietor's business.

Most sole proprietors do not realize that when they die their business dies with them. As the law recognizes no difference between business and personal assets of the sole proprietor, all of these assets pass to the estate of the proprietor for liquidation and the payment of death taxes and estate settlement costs. This means that it may be necessary at the proprietor's death to liquidate the business and, as a consequence, the estate and family lose its "going concern" value. The "forced" or auction sale of the business produces for the family only a fraction of what the business was worth just one day before the death of the proprietor.

In order to eliminate this drastic loss the sole owner should provide during his lifetime for the orderly disposition of the business at death. In many cases, the sole owner will not have heirs to take over the business because they lack the training, ability or desire to operate it. In such a situation, the most logical person to purchase the business at the proprietor's death is a key employee. The key employee is the ideal purchaser. He or she is usually the one' and only person, other than the owner, who is familiar with the day-to-day operation and potential of the business, and is therefore keenly aware of the business's true value.

One of the most efficient means of accomplishing the key employee buy-out is through the insured buy-sell agreement. The proprietor and one or more key employees enter into an agreement which provides that the proprietor's estate will sell the business to the employee at death. The employee agrees to pay the estate or family a stipulated amount for the business. The employee insures the life of the proprietor so that when the proprietor dies the cash to purchase the business will immediately become available. The insured agreement set up in this way is the most effective means of providing cash at the exact time needed.

To the proprietor, the insured employee buy-out has many advantages. The family receives full value for the business interest immediately upon death. Therre is no necessity for a liquidation of the business and the "going concern" value is thus preserved for the family. The estate is relieved of the burden of business management and liquidation. The close tie of the employee to the business provides an added incentive to continue payment. To provide additional comfort to both parties in the event of contingencies other than death, the agreement should also cover the terms that would apply if a sale of the interest arose because of the owner's disability, retirement or other lifetime event. Finally, the business credit position is improved as creditors know the business will continue to function after the death of the owner.

The major advantage to the employee is that the arrangement makes possible the acquisition and future ownership of the business. In most situations, the employee would probably not be able to accumulate enough cash to buy the business. In addition, the employee is provided job security through future employment.

Update:

Final Split-Dollar Regulations were issued by Treasury/IRS on Sept. 11, 2003. The final regulations made few, if any, substantial changes to the writings included already in Notice 2002-8 an thee Proposed Regulations.

This article is not intended to be used as tax or legal advice. It is always recommended that local counsel or a tax specialist be consulted on specific tax and legal matters.
Summary of Advantages

To the Estate or Family of the To the Purchasing Employee
Decease Sole Proprietor

A fair price for the deceased's The arrangement will give the
business interest is assured. employee a sense of equity
ownership in the business
without the sole proprietor's
sacrifice of immediate control.

Forced sale of the business to The business may be continued
Provide cash for payment of by the employee without
taxes and estate settlement costs interruption.
is avoided.

Funds received from the sale can The plan assures the surviving
provide a guaranteed income to key employee of the
the family of the deceased. This continuation of his or her
income will not be dependent position, as well as providing a
upon the future success or proprietary interest in the
operation of the business continuing business activity.
enterprise.

If properly structured, the The life insurance cash values
arrangement will avoid the increase year by year and are
expense and litigation which available for emergencies and
may be involved if the Internal financial opportunities
Revenue Service challenges the
value of the business for estate
tax purposes.


Patrick F. Olearcek, Esq. is a director of estate and business planning for MassMutual Financial Group.
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Copyright 2003 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Blue Chip Strategies
Author:Olearcek, Patrick F.
Publication:Franchising World
Date:Nov 1, 2003
Words:778
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