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“Wait and See” Succession Planning for Businesses.

Determining the correct method to sell your business is an endeavor since life circumstances fluctuate and divert every year. From an economic lockdown to debilitating health, what causes retirement tends to be a compounding of problems until one additional burden “breaks the camel’s back,” as the idiom goes. Without the time to develop a succession plan, clients rationally seek guidance from an attorney to devise a plan. Some clients know exactly what they want, while others feel uncertain about selecting the “right” plan for their family.

One of the more flexible options is a “wait and see” succession plan. We will discuss its application to C-corporations, but similar principles can apply to a partnership or LLC. For sole proprietorships, Family LLCs and LLPs have become popular estate planning tools.

Summarily, a “wait and see” plan involves a cross-owned (cross-purchase) life insurance policies to the surviving shareholders[1] that fund the corporation’s redemption or “buy-back” of the deceased or incapacitated shareholder’s shares. This results in multiple insurance policies, which may not be an issue for a small multi-family corporation. The corporation could pay the life insurance premiums through a taxable bonus compensation to the key employees.[2] A key employee-shareholder is typically the founder, elder, and figurehead of the firm’s reputation or operations.

The rationale for life insurance is (1) life insurance proceeds are tax-exempt for individuals without risks of alternative minimum tax,[3] and (2) the book value or the appraised fair market value of the corporate shares can be too large for a shareholder to spontaneously purchase with the unexpected death of a key employee-shareholder. The surviving shareholder’s uses the life insurance proceed to pay the company’s debt, caused by the forced buy-back of the key employee-shareholder’s shares at her passing.[4] The transfer of the tax-free life insurance proceeds from the surviving shareholder to the corporation can be a loan where the shareholder lends the money to the corporation or an immediate increase in the shareholder’s cost basis of corporations’ share.[5]

Should a corporation be the life insurance policyholder for a succession plan, the officers or shareholders may want to confirm that the requirements of the Pension Protection Act of 2006 are satisfied. One way to determine an employer’s competency is to find a consent form declaring the officer consents, in part, to the corporation insuring the life of the key employee, and it shall receive the death benefits upon the officer’s death.[6] If a corporation sells the life insurance policy to a shareholder or the shareholder leaves the company and no longer wants the cross-purchase of life insurance, each party should be obligated to resell the insurance policy to the other party or to grant the policy’s surrender.

Death and incapacity are the more technical and less negotiable events for a key employee-shareholder. Nevertheless, the surviving shareholders must also “wait and see” how the key employee plans out the later part of their life. The key employee may have a desire to retire, anxiety about new regulatory obligations, or frustration with the business encouraging resignation. The key employee may have routine family arguments about the differences between the older generation’s management style and the younger generation’s management style.

Depending on the relationship to other shareholders, the succession planner will consider who purchases the company, the purchase price, and the payment options. Usually, the corporation or the shareholders will have the option to purchase key employee’s shares as the employee makes the transition under their terms. The shareholders will purchase the key employees shares on a pro-rata basis. Other events may generate other governing instruments. For instance, antagonism with the key employee and her expected resignation may result in a higher purchase price methodology in exchange for the key employee signing a non-compete agreement, particularized to Michigan law.

The succession plan can require rigorous planning and complex legal documents. With a consultation with an attorney, clients can prepare for a transaction or catastrophe. Initial questions for prospective clients to consider include: how you want to be involved with the business during the transition to retirement, and what are your aspirations for your family’s participation in that business?

Thomas Oriet, Esq, LLM, EA, is an Of-Counsel attorney specializing in asset protection, estate planning, and agricultural law at the Law Offices of Casey D. Conklin.

[** The information in this article is not legal advice or tax advice, and this article must only be used for educational purposes. Please consult with an attorney before making any decision. This article cannot be used or relied upon for purposes of avoiding tax penalties. The author will not be updating the article due to changes in the law.]

[1] Or a trustee of those shareholders. [2] Treas Reg § 1.301-1(m)(2) (A corporation's payment of premiums on life insurance owned by a shareholder can be a § 301 distribution of property that lowers basis in the stock, which may result in capital gain once the adjusted basis of the stock is reduced to zero.) [3] IRC 101; 26 CFR § 1.101-1 [4] The buy-back is memorialized and enforced through a tailored purchase agreement of the shares. [5] IRC 1012; See e.g. Kasle v. United States, 75 F. Supp. 340, 341 (N.D. Ohio 1947) [6] IRC 101(j)(4)–(5) (there are more requirements under these subsections).


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