Close corporation plans allow surviving shareholders to purchase the shares of a deceased shareholder, with prearranged agreements and insurance policies used to facilitate the process. These plans help maintain the balance of shares among shareholders and prevent outside entities from attempting a takeover.
Close corporation plans are prearranged agreements that make it possible for surviving shareholders to purchase the outstanding shares of a deceased shareholder. In most cases, the agreement will provide the steps necessary to complete the purchase, including a formula for determining the number of shares each surviving shareholder can purchase. This provision helps ensure that the balance of shares among shareholders remains constant.
It is not unusual for shareholders wishing to establish a close corporation plan to be tasked with establishing a life insurance policy. There are two basic types of policies that can be created to assist in the closed corporation plan process. The individual share purchase plan involves each shareholder paying a portion of the premium that is considered representative of the total number of shares held by each individual shareholder. This plan tends to work very well if the number of shareholders is relatively small.
A second structure for the insurance policy would be the corporation’s stock purchase plan. Often used when the corporation has a large number of shareholders, the corporation pays the premiums associated with each shareholder. The value of the policy is determined by the formula used to determine the guaranteed unit price for each issued share. When a shareholder dies, the corporation in effect uses the insurance coverage to buy back the shares at the agreed unit price and then offers them for sale to the surviving shareholders.
With both types of insurance coverage associated with the close corporation plan, the premiums cannot be deducted as a business expense. However, any income generated from death benefits associated with the policies does not carry a tax liability. This helps ensure that the recipients of the redistributed shares do not incur any type of penalty for purchasing the shares.
A closed corporation plan can be an excellent strategy when shareholders prefer to keep the financial interest in the company within a select group of investors. The approach helps ensure that outside entities cannot attempt to buy the shares controlled by a recently deceased shareholder and set the stage for a takeover attempt. The close corporation plan can also help maintain a degree of stability at a time when the company may need to adjust to the death of a key shareholder.
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