How do buy-sell agreements affect business estate taxes?

The short answer is “Yes,” it is possible to make the price under the buy-sell agreement binding for estate tax purposes, but certain requirements must be followed.

In general, the price that is set, either specifically or by formula, in a buy-sell agreement will be accepted as the value of the business interest provided it was negotiated at arm’s length and the following seven conditions are met: (1) the estate is required by the agreement to sell the decedent’s business interest; (2) the buyer (the surviving business owners of the business entity itself) is required to purchase the business interest; (3) the business entity itself or the surviving business owners had a “right of first refusal” during the decedent business owner’s lifetime; and (4) the price under the agreement was fair and adequate when the agreement was entered into; (5) the buy-sell agreement is bona fide; (6) it is not a “device” to transfer property to family members for less than full and adequate consideration in money or money’s worth, and; (7) the terms are comparable to similar arrangements entered into by person’s in an arm’s-length transaction.

Of all these, perhaps (7) causes the most problem for an estate. The buy-sell agreement was entered into partly because the business owner’s interest was unmarketable and difficult to value. Thus, as a closely-held business, it is difficult to find a buy-sell agreement with “terms [that] are comparable” to it. A number of scholars and prominent estate planners have criticized this regulatory requirement.