CWS CWS Business Succession Planning 1 — Questions and Answers
Question 1: Which type of buy-sell agreement requires surviving business owners to purchase a deceased partner's interest?
- Entity purchase (redemption) agreement
- Cross-purchase agreement (Correct answer)
- Wait-and-see agreement
- One-way buy-sell agreement
Correct answer: Cross-purchase agreement
A cross-purchase agreement obligates the surviving owners to personally buy the deceased owner's business interest, funded typically through life insurance.
Question 2: What is the primary advantage of an entity purchase (stock redemption) buy-sell agreement over a cross-purchase agreement in a business with many owners?
- Lower cost basis for surviving owners
- Simplicity — the business holds fewer insurance policies than individual owners would (Correct answer)
- Better capital gains tax treatment
- No need for life insurance funding
Correct answer: Simplicity — the business holds fewer insurance policies than individual owners would
An entity purchase agreement requires only one life insurance policy per owner, whereas a cross-purchase requires each owner to hold policies on every other owner.
Question 3: A family limited partnership (FLP) is commonly used in business succession planning primarily for which purpose?
- Eliminating all estate taxes through unlimited marital deduction
- Transferring business interests to family members at a discounted valuation for gift and estate tax savings (Correct answer)
- Converting ordinary income to capital gains
- Avoiding step-up in basis at death
Correct answer: Transferring business interests to family members at a discounted valuation for gift and estate tax savings
FLPs allow business owners to transfer limited partnership interests at valuation discounts (lack of control and marketability), reducing gift and estate tax liability.
Question 4: What does the term 'key person insurance' refer to in the context of business succession planning?
- Life insurance on a business owner paid for by the business to offset financial loss from that person's death (Correct answer)
- Health insurance for essential employees
- Disability insurance for rank-and-file staff
- A buyout agreement funded by a savings plan
Correct answer: Life insurance on a business owner paid for by the business to offset financial loss from that person's death
Key person insurance is a life or disability policy owned and paid for by the business on a critical individual, providing funds to offset the financial impact of that person's death or disability.
Question 5: Under IRC Section 6166, what benefit is provided to estates with a significant closely held business interest?
- A full estate tax waiver on the business portion
- The ability to defer and installment-pay estate taxes attributable to the business over up to 14 years (Correct answer)
- A stepped-up basis for all business assets
- Exemption from the generation-skipping transfer tax
Correct answer: The ability to defer and installment-pay estate taxes attributable to the business over up to 14 years
IRC Section 6166 allows estates where the closely held business exceeds 35% of the adjusted gross estate to pay estate taxes in installments over up to 14 years at favorable interest rates.
Question 6: Which valuation discount is typically applied to a minority ownership interest in a closely held business due to the lack of ability to control operations?
- Lack of marketability discount
- Minority interest discount (Correct answer)
- Blockage discount
- Built-in gains discount
Correct answer: Minority interest discount
A minority interest discount reduces the value of a non-controlling ownership stake to reflect the inability to direct business decisions or compel distributions.
CWS CWS Business Succession Planning 1
Which type of buy-sell agreement requires surviving business owners to purchase a deceased partner's interest?