When business owners set up a buy-sell agreement funded by life insurance, they typically choose between two structures: cross-purchase or entity redemption. Both accomplish the same basic goal of providing liquidity to buy out a deceased or departing owner's interest. But they work differently, and those differences affect tax treatment, administration, and outcome in ways that matter.
Neither structure is universally better. The right choice depends on the number of owners, the entity type, the ages and health of the owners, and the broader estate and tax picture.
In a cross-purchase arrangement, each owner personally owns a life insurance policy on each of the other owners. When an owner dies, the surviving owners receive the death benefit directly and use it to purchase the deceased owner's interest from the estate.
The primary advantage of cross-purchase is the basis treatment for surviving owners. Because they purchased the interest with the insurance proceeds that were paid directly to themselves personally, their cost basis in the business increases to the purchase price. That has favorable capital gains implications if the business is later sold.
The practical limitation is policy count. Two owners need two policies. Three owners need six. Four owners need twelve. As the number of owners increases, administration becomes complex and premium disparity among owners of different ages can create equity issues.
In an entity redemption structure, the business itself owns the policies and receives the death benefit. The company then uses those proceeds to buy back the deceased owner's interest from the estate. Administration is simpler: one policy per owner regardless of how many owners there are.
The trade-off is that surviving owners do not receive a step-up in basis under this structure. Their ownership percentage increases as the deceased's shares are redeemed, but their cost basis stays the same. That can create a larger taxable gain at a future sale.
There is also a significant development worth knowing about. The U.S. Supreme Court's 2024 ruling in Connelly v. United States held that life insurance proceeds received by a corporation to fund a redemption are included in the company's value for estate tax purposes, even though those proceeds are immediately used to buy out the estate. That has changed how many advisors structure redemption arrangements. It is a planning conversation, not a reason to avoid this structure entirely, but it makes professional guidance more important than it was before.
One underappreciated fact is that buy-sell structures can be revisited. What made sense when the business had two equal owners may need to be reviewed when a third is added, when the business valuation changes significantly, or when an owner's health status changes and insurability becomes a factor.
A buy-sell agreement that has not been reviewed in several years, and whose funding has not been adjusted to match the current business value, is a plan that may not perform the way the owners expect when it is actually needed.
If you have questions about your current coverage or want to understand how your policy fits into the broader picture, I am happy to walk through it with you. Reach out at info@kusmiderconsulting.com or call (713) 487-8855. The conversation is where it actually gets useful.
As a full-service, independent brokerage based in Houston, Texas and available throughout the U.S., we specialize in aligning insurance solutions with broader financial strategies. We provide expert guidance, unbiased product recommendations, and ongoing policy oversight to ensure your coverage evolves with your needs.
Whether you're reviewing your own protection or advising clients, we’re committed to helping you make informed, confident decisions.
Elizabeth founded Kusmider Consulting with a simple goal: help people make informed insurance decisions without confusion or pressure.
As a Certified Financial Planner™, she brings a planning background to insurance work, focusing on how coverage fits into the broader financial picture, not just policy features.
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