How buy-sell agreements can protect your practice

2015 07 22 14 22 16 27 Mc Carthy John 200

This article from Heritage Financial Consultants draws on the same core materials that are included in the management consulting program for Levin Group clients. By gaining a deeper understanding of their financial situation and the options available, dentists can make informed decisions that will enable them to reach their retirement goals sooner.
— Roger P. Levin, DDS

John G. McCarthy III is a partner with Heritage Financial Consultants.John G. McCarthy III is a partner with Heritage Financial Consultants.

One day, Drs. Alex and Brad, both in their mid-40s, celebrated the 10th anniversary of owning Dental Practice Inc. as equal partners. The next morning, before going to work, Dr. Brad suffered a massive heart attack while jogging and died. Dr. Alex suddenly lost his longtime friend and practice partner. What's more, after the estate was settled, he found himself with a new co-owner -- Brad's wife, Melanie.

The result was chaos. Melanie had little interest or experience in running the practice. She needed cash for living expenses and asked Dr. Alex to buy out her interest in the business. But because most of his assets were tied up in the practice, he was short of cash. Unfortunately, Dr. Alex and Melanie were left with little choice but to sell the office on short notice for just a fraction of what they had hoped to receive.

Protecting the practice and owners

“A buy-sell agreement could have saved their practice while providing needed income for Brad's family after his death.”

How could this disaster have been avoided? A buy-sell agreement could have saved their practice while providing needed income for Brad's family after his death. Buy-sell agreements map out how ownership will change hands and how the transfer will be paid for in case of a co-owner's death, disability, or retirement. Typically, the agreement allows for the purchase of the departing doctor's ownership by the surviving partner or by the practice itself.

A buy-sell agreement, along with its proper funding, can achieve several goals:

  • Avoid liquidation of the practice
  • Facilitate an orderly continuation of office operations
  • Replace lost business income for a deceased owner's heirs
  • Set a purchase price for the deceased doctor's portion of the office
  • Reassure patients about the practice's stability

Using life insurance

Drafting a buy-sell agreement is only the first step. It will have limited benefit unless the surviving owner can afford to buy the deceased partner's share of the practice. Life insurance is often used as the preferred source of cash in this type of transaction. When a practice partner dies, the policy proceeds are used to buy the shares from the deceased owner's estate at a price set forth in the agreement.

There are two basic types of buy-sell arrangements: the "cross-purchase" agreement and the "stock redemption" agreement. Life insurance can be used to fund either.

In a cross-purchase agreement, in Drs. Alex and Brad's situation, each of them buys -- and is the owner and beneficiary of -- a life insurance policy on the other. On Brad's death, Alex receives the policy's death benefit, which he uses to purchase Brad's share from his estate. In turn, that cash payment gives Brad's family needed income to offset the loss of his earnings.

Cross-purchase plans have several advantages. For example, the surviving partner gets a "step up" in the income tax basis for the stock bought from the deceased's estate. This could reduce income taxes if the surviving partner later sells his share. In addition, with cross-purchase agreements, the insurance proceeds aren't subject to the corporate alternative minimum tax (AMT) or to the claims of corporate creditors.

Note that in the cross-purchase agreement, the income tax basis is the amount that the practice could be sold for in the future and reimbursed to the owner tax-free.

A cross-purchase agreement can be difficult to administer if there are many owners. For example, if there were eight doctors in a group practice, 56 separate policies would be needed.

In a stock redemption agreement, in this case, Dental Practice Inc., buys and owns insurance policies on the lives of Drs. Alex and Brad. When Dr. Brad dies, the practice buys his stock in the practice with the insurance proceeds. Stock redemption plans may make sense when there are multiple owners of a dental practice, there are large differences in age and ownership levels among the doctors, or the business is in a lower tax bracket than the owners. There are two potential drawbacks to these plans: The death proceeds received by the practice may be subject to the corporate AMT and the surviving shareholders don't get the benefit of an increase in the income tax basis of their shares when the practice redeems the stock.


Buy-sell agreements can help protect your practice and your family. Seek the guidance of a professional financial adviser who can help determine what type of buy-sell agreement makes the most sense for you.

John G. McCarthy III is a partner with Heritage Financial Consultants and a registered representative of Lincoln Financial Advisors. He can be reached at 410-771-5677. Heritage Financial Consultants is not an affiliate of Lincoln Financial Advisors. Lincoln Financial Advisors does not provide legal or tax advice.

Disclaimer: The comments in this article are not meant to be taken as financial advice. and the Levin Financial Group recommend that you always consult with your financial planner before making any significant changes in your financial situation.

The comments and observations expressed herein do not necessarily reflect the opinions of, nor should they be construed as an endorsement or admonishment of any particular idea, vendor, or organization.

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