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Buy-Sell Agreements And Deferred Compensation Plans

April 2017

Helen Connolly, Principal at Weyrich, Cronin & Sorra, Chartered

Buy-sell agreements are important for all business entities to protect the owners from having to sell/transfer their business interest without a plan in place. A business starts with great intentions of a long lasting relationship that will continue for the owners. Unfortunately circumstances such as an owner passing away, a divorce, retirement or a decision to leave the company often occur. If there is no agreement in place, it can become very problematic for the spouse, partners and their estate.

The perfect time to establish a buy-sell agreement is when establishing the business. If done properly it outlines what will happen if these circumstances occur, and can help avoid any tax issues or relationship problems for the owners. It also makes an easy transition for the owners and family members if they have to sell the business without causing operational disruptions.

As part of these agreements you can have a business valuation prepared, which will serve as a road map for admitting new partners and establishing a buy-in price for the sale of a business interest. This can help avoid serious disagreements between owners who want to sell out and the owners who want to remain. Valuations would need to be updated periodically as business changes occur. Fluctuations in the valuation price would come from additional growth or decline in the profit margins. Sometimes changes in the goodwill of the practice arising from a negative event can also reflect in the valuation price.

If the buy/sell documents are created with the desires and wishes of the owners, during a non-emotional time, and crafted in a professional manner it could mitigate legal disputes in the future.

Another sale/purchase arrangement option to the seller or buyer is a deferred compensation agreement. Internal Revenue Code section 409A governs “non-qualified deferred compensation” plans. These plans must comply with various rules regarding the timing of deferrals and distributions of payment. Deferral of compensation under these plans can be part of the sale of a business. By establishing a deferred compensation arrangement prior to the sale creates a liability that the buyer will assume. This assumed liability at acquisition will reduce the valuation price for the business. The seller picks up ordinary income from the transaction and the buyer will get a tax deduction at time of payment.
The final purchase price for the business may be negotiated to reflect the ordinary income treatment and the additional tax implications to the seller. They may increase the deferred compensation agreement to allow for the additional tax and thus increase the after tax payout.

Keep in mind it is imperative to have the proper guidance in drafting all agreements to make sure everything is in compliance to avoid penalties. I95

Helen Connolly,  Principal at Weyrich, Cronin & Sorra, Chartered, has over 30 years in accounting experience in private and public industry. She holds a Bachelor of Science Degree in Accounting from Towson University. Helen joined the firm in 2004 and became a partner in 2009. Her prior experience includes 14 years within the U.S. division headquarters of an international corporation and seven years in public accounting focusing on small business professionals. Her expertise covers a wide array of services such as Management Advisory, Federal and State Taxation Services, Financial Reporting and Compilations for a variety of clients. Helen is a member of the American Institute of Certified Public Accountants, Maryland Association of Certified Public Accountants and the National CPA Health Care Advisors Association. She enjoys reading, cooking and exercising.

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