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eneficiaries of the stockholders‟ estates. Since any value forgone would end up in the hands of the
intended beneficiary anyway, only the tax collector would be hurt. Although the IRS had long
challenged this practice, this strategy has been put to a formal end by legislation requiring that the
formula used result in a close approximation to fair market 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 outstanding shares and Lisa and Brad each own 10, a
corporate redemption agreement 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 between them (see Exhibit 9.8).
Exhibit 9.8 Corporate redemption versus cross-purchase agreement.
Once again, however, significant differences lie slightly below the surface. To begin with, many
such agreements are funded by the purchase of a life insurance policy upon 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
arrangement by succeeding to the ownership of the corporation. Or their compensation could be
adjusted to cover the additional cost.
If the corporation is not an S corporation, however, there is an additional consideration that must
not be overlooked. Upon Morris‟s death, the receipt of the insurance proceeds by the beneficiary of
the life insurance will be excluded from taxable income. However, a C corporation (other than certain