In a recently released private-letter ruling (for more on such rulings, see "Inside the IRS's Mind," this column, November, [Article link]), the IRS solved a big problem facing many private companies with stock-buyback agreements.
First, some background. The simplest buyback is what's known as a stock-redemption agreement, in which a company owns life insurance on each partner. When one dies, the insurance is used to purchase stock from family heirs, leaving the surviving partner as the sole owner. But creditors can seize insurance proceeds if the business looks shaky.
That's why many businesses now prefer a cross-purchase agreement, in which partners own insurance on each other's lives and make stock purchases directly when a partner dies. "Creditors can't get at the cash," explains Michael Fay, a senior partner at Boston law firm Hale and Dorr.
Until now, companies trying to switch from stock-redemption to cross-purchase buybacks couldn't transfer life-insurance policies from corporate owners to individuals without violating the "transfer for value" (TFV) rule and taking a stiff income-tax hit.
Offering a way around the TFV law, the new ruling -- Revenue Ruling #9309021 -- "will allow you to create a new partnership whose sole purpose is to acquire the corporation's life-insurance policies," says Fay. "Then that partnership will carry out the buyback, without incurring negative tax consequences."