Key Takeaways
- A buy-sell agreement decides who can buy an owner's share of the business, and at what price, if that owner dies, becomes disabled, or leaves. Without funding behind it, it is only a promise.
- Most agreements use one of two structures: a cross-purchase, where the owners buy each other out, or an entity purchase, where the business buys back the shares.
- The Supreme Court's 2024 decision in Connelly v. United States held that company-owned life insurance used to fund a redemption can increase the company's value for estate tax purposes. Many entity-purchase agreements deserve a second look.
- Life insurance is usually the most efficient way to fund a buyout at death: the cash arrives when it is needed, and it is generally income-tax-free.
For most business owners, the business is the largest asset they have. When one owner dies, the surviving owners want to keep running the company, and the family of the owner who passed wants to be paid fairly for that share. A buy-sell agreement is the contract that makes both of those things happen. The question most agreements never fully answer is simple: where does the money come from?
What a Buy-Sell Agreement Actually Does
A well-written buy-sell agreement sets out three things: which events trigger a buyout (death, disability, retirement, divorce, or departure), who has the right or obligation to buy, and how the price is determined. It keeps ownership in the hands of the people running the business, gives the departing owner's family a fair price instead of an illiquid minority stake, and gives everyone a clear process at a moment that is already hard.
The weak point is funding. If a co-owner dies and the agreement requires the survivors to buy a $4 million share, few businesses or partners have that much cash sitting idle. Borrowing it, paying it out of future profits, or selling assets to raise it all put strain on the business right when it has just lost a key leader.
Cross-Purchase vs. Entity Purchase
Cross-purchase. Each owner buys and owns a life insurance policy on the other owners. When an owner dies, the surviving owners receive the death benefit and use it to buy the deceased owner's shares directly from the estate. A key advantage is that the buyers receive a new, higher cost basis in the shares they purchase, which can reduce capital gains tax if they sell the business later. The drawback is complexity: with more than a few owners, the number of policies grows quickly, and differences in age and health can make premiums uneven between partners.
Entity purchase (stock redemption). The business owns one policy on each owner and buys back the shares itself when an owner dies. It is simpler to set up and administer, and the business pays the premiums. The trade-offs are that surviving owners do not get the basis increase a cross-purchase provides, and, since 2024, the death benefit itself may make the estate tax picture worse.
What the Connelly Decision Changed
In Connelly v. United States (2024), two brothers owned a business with an entity-purchase agreement funded by company-owned life insurance. When one brother died, the Supreme Court held that the insurance proceeds the company received counted toward the company's value for estate tax purposes, and that the company's obligation to redeem the shares did not offset that value. The result was a higher valuation of the deceased brother's share, and a larger estate tax bill, than the family expected.
For owners with an entity-purchase agreement funded by company-owned policies, especially those whose estates are near or above the federal exemption, this is worth reviewing with your estate attorney and CPA. Common alternatives include a cross-purchase structure, or a cross-purchase administered through a trust or a separate entity created to hold the policies, which can reduce the number of policies needed. Moving existing policies from one owner to another needs care: a transfer of an existing policy can trigger the transfer-for-value rule and make part of the death benefit taxable unless an exception applies, so the order of steps matters.
Keeping the Agreement Current
The most common problem we see is not the structure. It is an agreement that was signed years ago and never updated. The business has grown, but the price formula or the stated value has not, and the insurance was bought to match the old number. That leaves either a buyout price that shortchanges the family or a funding gap the survivors have to cover out of pocket. A good rule of thumb is to review the valuation and the coverage together, every year or two, and after any major change in the business.
Disability deserves attention too. An owner is more likely to become disabled during their working years than to die, and a buy-sell agreement that only addresses death leaves that risk unfunded. Disability buyout insurance can be paired with the life coverage so both triggers have money behind them.
Where We Fit In
We work alongside your attorney, who drafts the agreement, and your CPA, who handles valuation and tax questions, to design the insurance that funds it: the right structure, the right owner and beneficiary on each policy, and coverage amounts that match what the business is worth today. For larger buyouts, premium financing can make the coverage possible without pulling significant cash out of the business. If estate taxes are also part of the picture, our breakdown of the five ways to fund an estate tax bill shows how the pieces fit together.
A Note on This Article
- This article is for general educational purposes and does not constitute tax, legal, or investment advice. Buy-sell agreements and the tax rules that apply to them are complex and depend on your specific facts; please consult your CPA and attorney regarding your situation.