A cross-purchase agreement is a contract among partners or stockholders (shareholders) to purchase shares belonging to an incapacitated or deceased partner.
One of the most common ways of implementing a cross-purchase agreement is by having each partner buy life insurance policies on all the other owners, with the purpose of using the insurance money to fund the buyout. The number of shares that is then bought by each surviving owner depends on a pre-determined proportion agreed to by all owners.
There are several advantages to using the above scheme to ensure that the existing partners always remain control of the stocks in case of death of one of the partners. Some of these advantages include:
Tax issues – Life insurance proceeds are income-tax free so that surviving partners won’t have to be worried about being taxed for getting the insurance money and using it as funding for the buyout. Furthermore, by doing a cross-purchase agreement, there is little or no capital gain to be had since the surviving owners will experience a basis increase. This is another tax bonus in terms of capital gains tax, which in other sale of stock scenarios, would result in a hefty tax.
Basis increase – The surviving partners get a full basis credit when stocks are sold/bought through corporate cross-purchase plans.
There are also disadvantages, like having the partners use their personal incomes to pay for the insurance policy premiums, as well as difference in premium rates, which means that those whose insurance policies warrant smaller premiums will be at a disadvantage.