346 Planning and Forecasting
to purchase whatever stock he may still hold at his death. Such an arrangement
can be helpful with regard to both of Morris’s estate-planning goals: setting a
value for his stock that would not be challenged by the IRS and assuring suffi-
cient liquidity to pay whatever estate taxes may ultimately be owed.
There are two basic variations of these agreements. Under the most com-
mon, Morris would agree with the corporation that it would redeem his shares
upon his death for a price derived from an agreed formula. The second varia-
tion would require one or more of the other stockholders of the corporation
(e.g., Lisa) to make such a purchase. In both cases, in order for the IRS to re-
spect the valuation placed upon the shares, Morris will need to agree that he
will not dispose of the shares during his lifetime without first offering them to
the other party to his agreement at the formula price. Under such an arrange-
ment, the shares will never be worth more to Morris than the formula price, so
it can be argued that whatever higher price the IRS may calculate is irrelevant
to him and his estate.
This argument led some stockholders in the past to agree to formulas that
artificially depressed the value of their shares when the parties succeeding to
power in the corporation were also the main beneficiaries of the stockholders’
estates. Since any value forgone would end up in the hands of the intended ben-
eficiary any way, only the tax collector would be hurt. Although the IRS long
challenged this practice, this strategy has been put to a formal end by legisla-
tion requiring that the formula used result in a close approximation to fair mar-
ket value.
Which of the two variations of the buy-sell agreement should Morris
choose? If we assume for the moment that Morris owns 80 of the 100 out-
standing shares and Lisa and Brad each own 10, a corporate redemption agree-
ment leaves Lisa and Brad each owning half of the 20 outstanding shares
remaining. If, however, Morris chooses a cross-purchase agreement with Lisa
and Brad, each would purchase 40 of his shares upon his death, leaving them as
owners of 50 shares each. Both agreements leave the corporation owned by
Lisa and Brad in equal shares, so there does not appear to be any difference be-
tween them.
Once again, however, significant differences lie slightly below the sur-
face. To begin with, many such agreements are funded by the purchase of a life
insurance policy on the life of the stockholder involved. If the corporation
were to purchase this policy, the premiums would be nondeductible, resulting
in additional taxable profit for the corporation. In a subchapter S corporation,
such profit would pass through to the stockholders in proportion to their shares
of stock in the corporation. In a C corporation, the additional profit would
result in additional corporate tax. If, instead, Lisa and Brad bought policies
covering their halves of the obligation to Morris’s estate, they would be paying
the premiums with after-tax dollars. Thus, a redemption agreement will cause
Morris to share in the cost of the arrangement, whereas a cross-purchase
agreement puts the entire onus on Lisa and Brad. This burden can, of course,
be rationalized by arguing that they will ultimately reap the benefit of the