Provides a guaranteed buyer for your business interest (or how to avoid a fire sale)
When you die, your estate does not have to search for someone who is willing to buy your share of the business. Your estate will not be forced to sell your business interest at an unfairly low price to get the cash needed if your estate must pay estate taxes. Under the terms of the agreement, when any of the triggering events occur, there is a ready buyer for the share of the business. A buy-sell agreement spells out exactly who will buy your interest in the business, under what circumstances, and at what price.
Tip: For this to work, you must fund the buy-sell agreement.
Provides liquidity for the payment of estate taxes and other estate settlement expenses (but only if the agreement is funded)
Estate taxes, if owed, are due to the federal government nine months after death. In some states, the death taxes are due even sooner than that. The buy-sell agreement not only provides a buyer for the business interest but also specifies the value or valuation method, if the payment will be in a lump sum or installment, and when it will happen. If your estate is large and subject to estate taxes, your family will need enough cash to pay them. You want to be sure that they will be able to convert your portion of the business into cash quickly and at a fair price. Under a buy-sell agreement, the sale of the business interest can occur quickly, and your family can be spared the panic of just how to pay the estate taxes.
Caution: If the buyer does not have the cash or access to cash when needed for the buyout, the agreement won't serve any useful purpose. Make sure that the agreement specifies the plan to fund the buy-sell agreement and, even more importantly, that the funding takes place.
Tip: The applicable exclusion amount effectively exempts a certain amount of your gross estates from federal estate tax liability. If your estate is worth less than this amount, you may not owe estate taxes, and the benefit of a buy-sell agreement to provide liquidity for estate taxes would not be of much importance to you. However, you still may want the other benefits of a buy-sell agreement such as a guaranteed buyer.
Avoids potential conflicts of interest between surviving owners (if any) and your heirs
At your death, there is a natural conflict of interest between your surviving co-owners (if any) and your heirs. Generally, it is in your heirs' best interest to receive the largest amount of cash possible from the business. Likewise, it is generally in the surviving co-owners' best interest to continue the business operation without interruption and to keep liquidation costs to a minimum. Without a prearranged agreement, the differing needs of your heirs and your surviving co-owners are likely to result in a dispute. A buy-sell agreement can ensure that your plans for your business and for your heirs are carried out as you intended and are not met with resistance.
Can establish the value of the business for estate tax purposes, if structured properly
The buy-sell agreement may, under the right circumstances, set the fair market value (FMV) of an interest in the business when the agreement is executed. When the agreement is structured properly, the IRS will accept the FMV as the taxable value if certain conditions are met.
Caution: Buy-sell agreements between family members or related parties can be subject to close scrutiny by the IRS. The definition of "family member" includes your spouse, parents of you and your spouse plus their lineal descendants including spouses, and any other "natural objects of the transferor's bounty."