A buy-sell agreement is no better than its funding mechanism, which is necessary to ensure its workability from the viewpoints of both future buyers and sellers. Many buy-sell agreements are funded with life insurance. What is not found in many of buy-sell agreements is how the life insurance proceeds should be treated – are they a corporate asset or are they not?

Proceeds Are Not a Corporate Asset. One treatment would not consider the life insurance proceeds as a corporate asset for business valuation purposes. This treatment would recognize that life insurance was purchased on the lives of shareholders for the specific purpose of funding a buy-sell agreement. Under this treatment, life insurance proceeds, if considered as an asset in business valuation, would be offset by the company’s liability to fund the purchase of shares. Logically, under this treatment, the expense of life insurance premiums on a deceased shareholder’s life insurance would be added back into income as a non-recurring expense.

Proceeds Are a Corporate Asset. Another treatment would consider the life insurance proceeds as a corporate asset for business valuation purposes. In the business valuation, the proceeds would be treated as a non-operating asset of the company. This asset, together with all other net assets of the business, would be available to fund the purchase of shares of a deceased shareholder. Again, under this treatment, the expense of life insurance premiums on a deceased shareholder would be added back into income as a non-recurring expense. The choice of treatment of life insurance proceeds associated with buy-sell agreements can have a significant, if not dramatic, effect on the resulting position of a company following the receipt of life insurance proceeds and the repurchase of shares of a deceased shareholder. The choice of treatment also has an impact on the resulting position of any remaining shareholders.

If your client(s) has a process buy-sell agreement funded by life insurance, the amount to be paid for the stock is likely uncertain. Issues related to the treatment of life insurance have become much more important. If your client(s) have such a buy-sell agreement, we strongly urge you to review it promptly to be certain that valuation-related issues will not arise.