A Cross-Purchase Plan is an arrangement among business partners, typically within small businesses or partnerships, aimed at ensuring a seamless transfer of ownership interests in the case of the death, disability, or retirement of a partner. Under this plan, each partner purchases a life insurance policy on the life of the other partners. When a triggering event occurs, the death benefit from these policies is used to buy out the deceased or disabled partner’s ownership stake, allowing the remaining partners to retain control of the business.
Key Features of a Cross Purchase Plan
Life Insurance Policies
Each partner acquires a life insurance policy on the other partners, paying premiums with post-tax dollars. The departing partner’s share is purchased using the death benefit of these policies.
Ownership Transition
The transition of ownership is predetermined, reducing potential disputes or conflicts. This arrangement ensures the business continues to operate smoothly without the need for the departing partner’s family to be involved in the daily operations.
Valuation Method
The buyout price is often determined by an agreed-upon formula or valuation method outlined in the buy-sell agreement, ensuring fair compensation for the departing partner or their heirs.
Applicability
Partnership and Small Corporations
The Cross Purchase Plan is primarily used by small businesses and partnerships where the number of partners is manageable, typically two to five.
Equity Distribution
This plan allows for an equitable distribution of the deceased partner’s shares among the surviving partners, maintaining a balanced ownership structure.
Historical Context
The concept of the Cross Purchase Plan has been around for many decades, evolving as businesses recognized the need for structured succession planning. The plan helps avoid the liquidation of assets or company dissolution that can occur without a predefined succession strategy.
Examples
Example 1: A Small Law Partnership
In a law firm with three partners, each partner holds life insurance policies on the other two partners. When Partner A passes away, Partners B and C use the death benefit proceeds from their respective insurance policies to purchase Partner A’s shares, keeping the firm operational.
Example 2: Family-Owned Business
In a family-owned bakery, the two siblings who own the bakery enter into a Cross Purchase Plan. Each buys a life insurance policy on the other. When one sibling dies unexpectedly, the surviving sibling uses the life insurance proceeds to buy out the deceased sibling’s business interest from their family, preventing any disagreements and maintaining control of the bakery.
Comparisons
Cross Purchase Plan vs. Entity Purchase Plan
- Cross Purchase Plan: Each partner buys and owns policies on every other partner. It suits businesses with fewer partners.
- Entity Purchase Plan: The business entity itself purchases a single policy on each partner and buys out the deceased partner’s interest. Ideal for companies with more partners.
Related Terms
- Buy-Sell Agreement: A legal contract outlining the terms and conditions under which a partner’s share of a business may be sold in case of death, disability, or departure.
- Life Insurance: A contract under which an insurer promises to pay a designated beneficiary a sum of money upon the death of the insured person, used in Cross Purchase Plans to fund the buyout.
- Business Succession Planning: The process of identifying and preparing for the transition of business ownership and managerial control.
FAQs
What happens if an insurance policy isn't sufficient to cover the buyout?
Is the death benefit from the life insurance taxable?
Can a Cross Purchase Plan be altered?
References
- IRS Guidelines on Buy-Sell Agreements
- Estate Planning for Family Business Owners, ISBN: 978-1572484882
Summary
The Cross Purchase Plan stands out as a vital tool for small businesses and partnerships, providing a structured and fair approach to succession planning. With each partner insuring against the loss of others, the business secures its future against unforeseen disruptions and ensures continuity while safeguarding the interests of all parties involved.
For more detailed information on related topics, see [Partnership Life and Health Insurance].
