Accounting
Buy-sell agreements and their tax and insurance considerations for surviving partners
There are two significant reasons for a client to have an updated and funded buy-sell agreement. One is to allow the surviving partner to maintain sole control of the business if one of the owners or partners were to die prematurely or become disabled.
The other is to provide an immediately available sum of tax-free dollars to pay the deceased partner’s family for their share of the business or practice. A written agreement would establish an updated value of the business, how much money the deceased’s partner’s family would receive, over what period of time and most importantly, where the funds needed to pay the deceased partner’s family would come from.
Having discussed the value, terms, mechanics and funding beforehand would not only provide for an orderly transition of the business but also avoid unnecessary disputes settled by costly litigation.
Doing so would also prevent key people, employees, vendors and customers from leaving the business, thereby maintaining the full value of the business or practice for the surviving partner and their family. Lastly, a properly drafted, funded and annually updated valuation of the business could peg the value of a business for estate tax purposes.
There are basically three types of buy-sell agreements: cross-purchase, stock redemption, and wait and see. For the purposes of this article, we’ll focus on the two most popular: the cross-purchase and stock redemption. The wait and see has components of both types of agreements but doesn’t require a decision until death occurs. The cross-purchase agreement is an agreement made directly between the partners of a business or practice. Each partner is the owner, beneficiary and premium payor of the other partner’s life Insurance policy. As always, there are benefits and detriments to any planning options and the cross-purchase is no exception.
In a cross-purchase agreement, the distinct tax benefits to the surviving partner are that at their subsequent death, their family would receive a step up in basis to the current value of the business. For example, if a business is initially valued at $1million and then over 20 years later it’s worth $3 million, there would be no capital gains tax at the subsequent death of the surviving partner on the $2 million gain as the surviving partner in a cross-purchase agreement would receive a stepped-up basis at death to the $3 million.
One of the detriments of such an agreement is that the value of the personal shares of the business are subject to the claims of the creditors. In addition, if there are three partners, there could be as many as six life insurance policies required, and 12 policies if there were four partners involved. That aside, there would be disparities as to the cost of a particular amount of life Insurance coverage for a partner in their 60s in excellent health, as opposed to a partner in their 70s in not such good health. Equalizing the individual costs for a business or practice with four or more partners could be an administrative burden.
The second type of a buy-sell agreement is called a stock redemption. In this type of an agreement the mechanics work differently. Instead of the partners owning the policies on each other’s lives, paying for one another’s premiums and being each other’s beneficiary, the business is the owner, premium payor and beneficiary of each partner’s policy. This type of arrangement makes the administration easier and equalizes the different policy charges as well as reduces the number of policies required to provide the insurance coverage for several partners. It also shields the value of the shares of the business from personal creditors.
However, the detriment to that type of an agreement is severe in that at the death of a partner there is no step up in basis in the value of the business for the surviving partner’s family at their passing. Using the prior example, if the initial value of the business or practice was $1 million and then over 20 years later, upon the death of the first partner, the value of the business was determined to be $3 million, the estate of the surviving owner would be required to pay a capital gains tax of $2 million with a basis of $1million rather than the $3 million it would have been with a cross-purchase agreement.
The Supreme Court ruling on June 6 in the case of
Buy-sell agreements frequently utilize life insurance to provide the funding mechanism for payment of the purchase price upon death, disability, retirement or a specifically mentioned triggering mechanisms outlined in the buy-sell agreement such as divorce, unresolvable differences or bankruptcy. This source of funding is designed to have the surviving partner receive the tax-free death benefit in the most tax efficient manner, which would then be used to purchase the shares of the deceased partner from their family.
Since we’ll be focusing on the use of four different types of life insurance, a brief explanation of each type of life insurance policy that could be used is in order. Term life insurance can be purchased with a five- to 40-year term of coverage where the death benefit, the premium and the duration of coverage are all guaranteed. Term insurance provides a death benefit only and is the most popular and least expensive type of coverage simply because the coverage contractually ceases to exist at the ages of 80 to 82. As a result, only 2% of term insurance coverage is ever paid out as a death benefit. However, for business owners who intend to retire or sell their business or practice before the age of 80, and only want to be protected in the event of death, term insurance is a good choice. Since a disability is more likely to occur than a premature death, it’s a good idea to address a disability by funding it with a disability buyout policy.
If one wants to guarantee their coverage beyond age 82, they can utilize a guaranteed universal life insurance policy, which for a higher annual premium can guarantee the death benefit, cost and duration of coverage up to age 120. It should be noted that the longer one wants their coverage guaranteed to last, the higher the cost.
For those business owners and partners of a practice that want to utilize life insurance for its living benefits as well as its death benefit, they can use a whole life policy with a guaranteed premium and tax- free death benefit, based on a fixed return. Another option would be a variable life policy. This type of policy’s return is based on the returns of the stock market and is not guaranteed but may provide a higher or lower return. In either case, in addition to having provided an income tax-free death benefit during the partner’s working years, the policy could have accumulated a significant build-up of tax deferred internal cash value. Then at retirement (beyond age 59 and a half) when the death benefit is no longer needed, the partners could begin withdrawing the policy’s cash value to supplement their retirement on a 100% tax-free basis, utilizing a strategy of loans and withdrawals that never have to be paid back as long as the policy survives the insured. This and other split-dollar arrangements (such as premium sharing) are an extremely popular strategy for those businesses with an adequate cash flow. This is known as a private pension. or supplemental owners retirement plan.
Similar steps can also be taken to ensure a key employee remains in the business during any such turbulent times by providing them with a deferred compensation plan. Such a plan can merely provide a death benefit only using simple term insurance, or arrangements can be made to use a whole life or variable life insurance policy that in addition to providing a death benefit, also accumulates cash value on a tax-deferred basis. This accumulation can, upon the key person’s retirement, be used to supplement their income with tax-free distributions, but only if they fulfill their end of the bargain, i.e., remaining at their place of business for a specified number of years set at the owner’s discretion. This strategy is commonly called a supplemental executive retirement plan.
Final regulations now identify certain partnership related-party “basis shifting” transactions as “transactions of interest” subject to the rules for reportable transactions.
The final regs apply to related partners and partnerships that participated in the identified transactions through distributions of partnership property or the transfer of an interest in the partnership by a related partner to a related transferee. Affected taxpayers and their material advisors are subject to the disclosure requirements for reportable transactions.
During the proposal process, the Treasury and the Internal Revenue Service received comments that the
- Increased dollar threshold for basis increase in a TOI. The threshold amount for a basis increase in a TOI has been increased from $5 million to $25 million for tax years before 2025 and $10 million for tax years after.
- Limited retroactive reporting for open tax years. Reporting has been limited for open tax years to those that fall within a six-year lookback window. The six-year lookback is the 72-month period before the first month of a taxpayer’s most recent tax year that began before the publication of the final regulations (
slated for Jan. 14 in the Federal Register). Also, the threshold amount for a basis increase in a TOI during the six-year lookback is $25 million. - Additional time for reporting. Taxpayers have an additional 90 days from the final regulation’s publication to file disclosure statements for TOIs in open tax years for which a return has already been filed and that fall within the six-year lookback. Material advisors have an additional 90 days to file their disclosure statements for tax statements made before the final regulations.
- Publicly traded partnerships. Because PTPs are typically owned by a large number of unrelated owners, the final regulations exclude many owners of PTPs from the disclosure rules.
The identified transactions generally result from either a tax-free distribution of partnership property to a partner that is related to one or more partners of the partnership, or the tax-free transfer of a partnership interest by a related partner to a related transferee.
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The tax-free distribution or transfer generates an increase to the basis of the distributed property or partnership property of $10 million or more ($25 million or more in the case of a TOI undertaken in a tax year before 2025) under the rules of IRC Sections 732(b) or (d), 734(b) or 743(b), but for which no corresponding tax is paid.
The basis increase to the distributed or partnership property allows the related parties to decrease taxable income through increased cost recovery allowances or decrease taxable gain (or increase taxable loss) on the disposition of the property.
The Treasury Department and the Internal Revenue Service proposed new rules for the tax credit for qualified commercial clean vehicles, along with guidance on claiming tax credits for clean fuel under the Inflation Reduction Act.
The
The credit is the lesser amount of either 30% of the vehicle’s basis (15% for plug-in hybrid EVs) or the vehicle’s incremental cost in excess of a vehicle comparable in size or use powered solely by gasoline or diesel. A credit up to $7,500 can be claimed for a single qualified commercial clean vehicle for cars and light-duty trucks (with a Gross Vehicle Weight Rating of less than 14,000 pounds), or otherwise $40,000 for vehicles like electric buses and semi-trucks (with a GVWR equal to or greater than 14,000 pounds).
“The release of Treasury’s proposed rules for the commercial clean vehicle credit marks an important step forward in the Biden-Harris Administration’s work to lower transportation costs and strengthen U.S. energy security,” said U.S. Deputy Secretary of the Treasury Wally Adeyemo in a statement Friday. “Today’s guidance will provide the clarity and certainty needed to grow investment in clean vehicle manufacturing.”
The NPRM issued today proposes rules to implement the 45W credit, including proposing various pathways for taxpayers to determine the incremental cost of a qualifying commercial clean vehicle for purposes of calculating the amount of 45W credit. For example, the NPRM proposes that taxpayers can continue to use the incremental cost safe harbors such as those set out in Notice 2023-9 and Notice 2024-5, may rely on a manufacturer’s written cost determination to determine the incremental cost of a qualifying commercial clean vehicle, or may calculate the incremental cost of a qualifying clean vehicle versus an internal combustion engine (ICE) vehicle based on the differing costs of the vehicle powertrains.
The NPRM also proposes rules regarding the types of vehicles that qualify for the credit and aligns certain definitional concepts with those applicable to the 30D and 25E credits. In addition, the NPRM proposes that vehicles are only eligible if they are used 100% for trade or business, excepting de minimis personal use, and that the 45W credit is disallowed for qualified commercial clean vehicles that were previously allowed a clean vehicle credit under 30D or 45W.
The notice asks for comments over the next 60 days on the proposed regulations such as issues related to off-road mobile machinery, including approaches that might be adopted in applying the definition of mobile machinery to off-road vehicles and whether to create a product identification number system for such machinery in order to comply with statutory requirements. A public hearing is scheduled for April 28, 2025.
Clean Fuels Production Credit
The Treasury the IRS also released guidance Friday on the Clean Fuels Production Credit under Section 45Z of the Tax Code.
Section 45Z provides a tax credit for the production of transportation fuels with lifecycle greenhouse gas emissions below certain levels. The credit is in effect in 2025 and is for sustainable aviation fuel and non-SAF transportation fuels.
The guidance includes both a
“This guidance will help put America on the cutting-edge of future innovation in aviation and renewable fuel while also lowering transportation costs for consumers,” said Adeyemo in a statement. “Decarbonizing transportation and lowering costs is a win-win for America.”
Section 45Z provides a per-gallon (or gallon-equivalent) tax credit for producers of clean transportation fuels based on the carbon intensity of production. It consolidates and replaces pre-Inflation Reduction Act credits for biodiesel, renewable diesel, and alternative fuels, and an IRA credit for sustainable aviation fuel. Like several other IRA credits, Section 45Z requires the Treasury to establish rules for measuring carbon intensity of production, based on the Clean Air Act’s definition of “lifecycle greenhouse gas emissions.”
The guidance offers more clarity on various issues, including which entities and fuels are eligible for the credit, and how taxpayers determine lifecycle emissions. Specifically, the guidance outlines the Treasury and the IRS’s intent to define key concepts and provide certain rules in a future rulemaking, including clarifying who is eligible for a credit.
The Treasury and the IRS intend to provide that the producer of the eligible clean fuel is eligible to claim the 45Z credit. In keeping with the statute, compressors and blenders of fuel would not be eligible.
Under Section 45Z, a fuel must be “suitable for use” as a transportation fuel. The Treasury and the IRS intend to propose that 45Z-creditable transportation fuel must itself (or when blended into a fuel mixture) have either practical or commercial fitness for use as a fuel in a highway vehicle or aircraft. The guidance clarifies that marine fuels that are otherwise suitable for use in highway vehicles or aircraft, such as marine diesel and methanol, are also 45Z eligible.
Specifically, this would mean that neat SAF that is blended into a fuel mixture that has practical or commercial fitness for use as a fuel would be creditable. Additionally, natural gas alternatives such as renewable natural gas would be suitable for use if produced in a manner such that if it were further compressed it could be used as a transportation fuel.
Today’s guidance publishes the annual emissions rate table that directs taxpayers to the appropriate methodologies for calculating carbon intensities for types and categories of 45Z-eligible fuels.
The table directs taxpayers to use the 45ZCF-GREET model to determine the emissions rate of non-SAF transportation fuel, and either the 45ZCF-GREET model or methodologies from the International Civil Aviation Organization (“CORSIA Default” or “CORSIA Actual”) for SAF.
Taxpayers can use the Provisional Emissions Rate process to obtain an emissions rate for fuel pathway and feedstock combinations not specified in the emissions rate table when guidance is published for the PER process. Guidance for the PER process is expected at a later date.
Outlining climate smart agriculture practices
The guidance released Friday states that the Treasury intends to propose rules for incorporating the emissions benefits from climate-smart agriculture (CSA) practices for cultivating domestic corn, soybeans, and sorghum as feedstocks for SAF and non-SAF transportation fuels. These options would be available to taxpayers after Treasury and the IRS propose regulations for the section 45Z credit, including rules for CSA, and the 45ZCF-GREET model is updated to enable calculation of the lifecycle greenhouse gas emissions rates for CSA crops, taking into account one or more CSA practices.
CSA practices have multiple benefits, including lower overall GHG emissions associated with biofuels production and increased adoption of farming practices that are associated with other environmental benefits, such as improved water quality and soil health. Agencies across the Federal government have taken important steps to advance the adoption of CSA. In April, Treasury established a first-of-its-kind pilot program to encourage CSA practices within guidance on the section 40B SAF tax credit. Treasury has received and continues to consider substantial feedback from stakeholders on that pilot program. The U.S. Department of Agriculture invested more than $3 billion in 135 Partnerships for Climate-Smart Commodities projects. Combined with the historic investment of $19.5 billion in CSA from the Inflation Reduction Act, the department is estimated to support CSA implementation on over 225 million acres in the next 5 years as well as measurement, monitoring, reporting, and verification to better understand the climate impacts of these practices.
In addition, in June, the U.S. Department of Agriculture published a Request for Information requesting public input on procedures for reporting and verification of CSA practices and measurement of related emissions benefits, and received substantial input from a wide array of stakeholders. The USDA is currently developing voluntary technical guidelines for CSA reporting and verification. The Treasury and the IRS expect to consider those guidelines in proposing rules recognizing the benefits of CSA for purposes of the Section 45Z credit.
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