What is a Close Corporation Plan?

Close corporation plans are pre-arranged agreements that make it possible for surviving stockholders to purchase the outstanding shares of a deceased shareholder. In most cases, the agreement will provide the steps necessary to make the purchase, including a formula for determining the number of shares that may be acquired by each of the surviving shareholders. This provision helps to ensure that a balance of shares among the shareholders remains constant.

It is not unusual for shareholders who wish to set up a close corporation plan to accomplish the task with the establishment of a life insurance policy. There are two basic types of policies that may be created to aid in the process of the close corporation plan. The individual stock purchase plan involves each stockholder paying a portion of the premium that is considered to be 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 stock purchase plan. Often employed when the corporation has a large number of shareholders, the premiums associated with each shareholder are paid by the corporation. The value of the policy is determined by the formula used to determine the guaranteed unit price for each issued share. When a shareholder passes away, the corporation in effect uses the insurance coverage to buy back the shares at the agreed upon 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 that is generated from the death benefits associated with the policies do not carry a tax liability. This helps to ensure that the recipients of the redistributed shares do not incur any type of penalty for purchasing the shares.

A close corporation plan can be an excellent strategy when the shareholders prefer to keep the financial interest in the company within a selected group of investors. The approach helps to ensure that outside entities cannot attempt to purchase the shares controlled by a recently deceased shareholder and lay the foundation for a takeover attempt. The close corporation plan can also help maintain a degree of stability in a time when the company may need to adjust to the death of a key shareholder.