Typical Cross Option agreements and the problems they create

But what about the impact a standard cross option agreement has on someone’s estate?

If you or a business partner dies their share will pass to their spouse or beneficiaries through their will. This is now deemed to be part of their estate. Whilst this share is held and the business continues trading then the assets could be exempt from Inheritance Tax if they qualify for Business Property Relief (BPR). Once the Cross Option has been affected then BPR is no longer available on the proceeds ie from any life assurance. The spouse’s assets assessable for Inheritance Tax (IHT) have now increased by the funds received from the life assurance policy risking 40% of the proceeds to IHT, which dependant on the size of the business could be a significant loss.

These assets are also now at risk from attack from any future remarriage claims, creditors or bankruptcy and Long Term Care costs.

What about the consequences a standard Cross Option agreement has for the surviving business partner?

With a standard Cross Option Agreement the surviving partner now owns 100% of the company. This is fine whilst the business is still trading and whilst BPR is still applicable.

However, what would happen when they decide to sell the business?

Now their personal estate will be increased to include the proceeds from the sale, as for the spouse this leaves them wide open to attack from Inheritance tax, creditors / bankruptcy, divorce settlements and Long Term Care costs.

Typical Cross Option Agreement

 

Typical Cross Option Agreement diagram

 

(i) Each Director leaves their share of the Business to their beneficiaries via their Will.
(ii) Cross Option Agreement established to enable one Director to purchase the other Director’s share of the business in the event of their death.
(iii) Life Assurance policies taken out by the company in order to fund the purchase of the shares / partnership.

 

Typical Cross Option-executed diagram

 

(iv) On the death of Director A, his shareof the business passes through the Will to his beneficiaries. The Life Assurance policy pays out. The company can then execute the Cross-Option Agreement, using the Life Assurance proceeds to purchase Director A’s share of the business.
(v) This results in Director A’s beneficiaries receiving the life assurance proceeds, and Director B owning 100% of the company.

 

Typical Cross Option beneficiaries diagram

Consequences to
Director A’s beneficiaries
Consequences to
Director B
Beneficiaries now have the funds from the Life Assurance policy.

These funds are now part of their estates and so will be assessable for Inheritance Tax when they die.

These funds are also at risk from claims from divorce, remarriage, bankruptcy and long term care.
3rd Party Claims
Director B will now own 100% of ABC Ltd which is at risk from divorce, remarriage, bankruptcy and long term care.

IHT

Whilst trading, Business Property Relief is applicable. However if he sells the business, the cash proceeds will then be part of his estate and so will be assessable for Inheritance Tax when he dies.

CGT

On sale, the growth in Director B’s share has increased and hence more CGT payable than necessary.

 

Example of potential Tax Liability

Example of potential Tax Liability diagram

Example of potential Capital Gains Tax Liability:
If we assume that the business is eligible for Entrepreneurs Relief then the Capital Gains Tax (CGT) rate is 10%.

CGT payable on sale = £180,000

Example of potential Inheritance Tax liability:
Director A and Director B each own 50% of ABC Ltd which is valued at £1,800,000.
Director A dies leaving 50% of the business to his beneficiaries. The Cross Option Agreement is executed resulting in £900,000 entering the beneficiaries’ estate.

When the beneficiaries die, the potential IHT bill on these funds is 900,000 x 40% = £360,000
Subsequently, Director B decides to sell the business resulting in £1,800,000 entering his estate.
When Director B dies he leaves a potential IHT bill of £1,800,000 x 40% = £720,000

A combined tax bill for the surviving director of £720,000 + £180,000 = £900,000

The potential combined IHT bill = £360,000 + £720,000 = £1,080,000

How do Countrywide’s Company Wills and Cross Option Agreements Differ?

Countrywide offers business estate planning tailor made to suit you and your business. It takes the Standard planning options available on the High Street a significant step further.

Countrywide’s planning provides this significant protection to the business and reduces the possible impact of Inheritance Tax dramatically. Furthermore the business and proceeds from a future sale of the business is protected for the bloodline from Inheritance Tax (IHT), remarriage, divorce and separation, creditor claims and Nursing Care Fees.

Our Planning leaves each partner or director’s share of their business to individual Family Trusts through appropriate Clauses written in to their Wills.

Furthermore the appropriate Life Cover will also be protected ensuring that these proceeds do not impact on the surviving individual’s estate.

Once the Cross Option has been executed, our planning ensures that the proceeds from any Life Assurance policy also do not form part of the beneficiary’s estate. These funds are now protected against any of the risks named above yet the surviving spouse and beneficiaries still have full access to the Trust assets.

So how does this benefit the remaining business partner?

Once again, the use of Trusts ensures that the surviving business partner still retains their original share of the business and still has the fullest of control on the whole of the business as he/she is named as a Trustee of the Trust(s) which now own the deceased Director’s shares.

This same Trust can also be utilised as a further efficient income tax planning tool. Now that a proportion of the business is held in trust any dividends paid into the Trust(s) could be distributed to beneficiaries of the trusts who may well have nil or low rate income tax.

Should the surviving Director(s) decide to sell the business only their original share of the business will enter their estate. The remaining share will belong to Trust for which the surviving Director and his/ her family are beneficiaries.

This share is also protected and cannot be assessed for Inheritance Tax (IHT) purposes and provides protection from attack by Long Term Care Costs, divorce, and bankruptcy.

 The information given does not provide specific advice and may not be suitable to your individual circumstances.

Please not that the Financial Conduct Authority do not do not regulate some forms of Trust products & services. These services are provided by our sister company Countrywide Tax & Trust Corporation Ltd