Buy-Sell Agreement Life Insurance: Cross-Purchase vs. Entity Redemption After Connelly

A buy-sell agreement is a contract among business owners that says who buys an owner’s share when that owner dies, and at what price. Life insurance is how most owners make sure the money is there when it’s needed. There are three common designs. In a cross-purchase, the owners insure each other. In an entity redemption, the company insures each owner. In a one-way plan, a single buyer insures a single owner. Since the Supreme Court’s 2024 decision in Connelly v. United States, the choice between them matters more for owners whose estates could owe federal estate tax.

Your attorney drafts the agreement, your CPA weighs the taxes, and we place the coverage. See also life insurance for business partners.

The three structures, side by side

	Cross-purchase	Entity redemption	One-way
Who owns the policies	Each owner, on the other owners	The business, on each owner	The buyer, on the owner
Who buys the share	The surviving owners	The business	The named buyer (a key employee or successor)
Number of policies	Each owner insures every other owner: 2 owners = 2 policies, 3 = 6, 4 = 12	One per owner	One
Buyer’s tax basis	Survivors generally get a cost basis equal to what they paid	Depends on entity type. Ask your CPA	The buyer’s cost basis
Where the death benefit lands	With the surviving owners	With the company, which can raise the company’s value (see Connelly)	With the buyer
Often fits	Two or three owners	Many owners, or when owners want the company to handle premiums	A sole owner with a planned successor

Hybrid (“wait-and-see”) agreements give the surviving owners the first option to buy and require the company to buy if they decline. The Connelly agreement worked that way.

How life insurance funds the agreement

Size each policy to the owner’s share of the agreed value. In a hypothetical $2 million business, a 60% owner’s share is worth about $1.2 million, so that’s what the buyer needs. When the value goes up, the coverage should too.

Term or permanent? Term coverage fits an agreement with a horizon, such as owners planning to sell in 10 or 15 years. Permanent coverage fits an agreement meant to last a career, and it stays in force even if an owner’s health changes later. Cash value in a permanent policy can also help fund a buyout when a partner retires instead of dying. Indexed universal life is one option there. It’s life insurance, not an investment. See funding a buy-sell with IUL.

Death isn’t the only trigger. Good agreements also cover disability, retirement and departure, which are usually funded another way: disability buyout coverage, an installment note or a reserve fund.

Entity-owned policies need paperwork. When the business owns the policy, the employer-owned life insurance rules in IRC §101(j) apply. The insured must get written notice and give written consent before the policy is issued, and the business generally files IRS Form 8925 each year. One of the statutory exceptions covers proceeds used to buy the insured’s ownership interest from their family or estate. Our key person insurance guide covers these rules in detail.

Be careful when you restructure. Moving existing policies between owners can trigger the tax code’s transfer-for-value rule, which can make part of the death benefit taxable. The exceptions include transfers to the insured, to a partner of the insured, to a partnership the insured is a partner in, or to a corporation where the insured is a shareholder or officer. A transfer from a corporation to a co-shareholder isn’t on that list by itself, so have your attorney review any transfer first.

The valuation clause: where most agreements break

The price section is the heart of the agreement. Common methods:

• A fixed price, updated by the owners at set intervals (often annually) in a signed certificate of value
• A formula, such as a multiple of earnings or book value
• An independent appraisal at the time of death
• A combination, such as an appraisal if the fixed price hasn’t been updated recently

Two lessons:

1. Follow your own process. In Connelly, the agreement called for an outside appraisal. Instead, the surviving brother and his late brother’s son agreed on a $3 million price “in an amicable and expeditious manner.” The IRS later valued the shares at $5.3 million.
2. The agreement price doesn’t automatically set the estate-tax value. The Court noted that an agreement’s price is “ordinarily not dispositive” for estate tax. Under IRC §2703, a right to buy for less than fair market value is ignored for estate tax valuation unless the agreement is a bona fide business arrangement, isn’t a device to pass the business to family for less than full value, and has terms comparable to arm’s-length deals.

Revisit the value every year and after big events, then adjust the coverage to match.

What Connelly v. United States changed

Brothers Michael and Thomas Connelly owned a building supply company. Under their agreement, the company had to redeem a deceased brother’s shares if the survivor didn’t buy them, and the company carried $3.5 million of life insurance on each brother to fund that. When Michael died, the company paid his estate $3 million for his 77.18% stake.

The IRS counted the life insurance proceeds as a company asset. It valued the company at $6.86 million and Michael’s shares at about $5.3 million, which produced $889,914 in additional estate tax. On June 6, 2024, a unanimous Supreme Court agreed with the IRS. It held that the company’s obligation to redeem shares at fair market value did not offset the insurance proceeds earmarked for that purchase.

What it means in practice:

• With entity redemption, insurance proceeds can increase the company’s value for federal estate tax purposes. The deceased owner’s share gets more valuable on paper, and the coverage may fall short of buying it at full fair market value.
• The Court pointed to an alternative. It noted that the brothers “could have used a cross-purchase agreement,” where the proceeds go to the surviving owner instead of the company. It also acknowledged that cross-purchase plans have drawbacks: each owner pays premiums on the others, and there are separate tax consequences.
• The holding is narrow. The Court said it was not holding that a redemption obligation can never reduce a company’s value.
• Estate size matters. The IRS filing threshold for people who die in 2026 is $15,000,000, measured against the gross estate plus certain lifetime gifts. If your estate, including your share of the business, could come anywhere near it, have your attorney and CPA review your structure.

Buy-sell review checklist

1. Find the signed agreement and confirm its structure. If there isn’t one, start there.
2. Check the valuation clause and when the value was last updated.
3. Compare each policy’s death benefit with each owner’s current share value.
4. Confirm that policy owners and beneficiaries match the agreement.
5. For entity-owned policies, confirm notice and consent were done before issue and that Form 8925 is filed.
6. Ask your attorney and CPA whether Connelly affects you.
7. Make sure disability and retirement triggers are funded.
8. Put an annual review on the calendar.

Frequently asked questions

What is a buy-sell agreement?

It’s a legal contract among a business’s owners. It sets what happens to an owner’s share at death, and often at disability, retirement or departure: who buys it, at what price and how the purchase is funded. Life insurance usually funds the death trigger.

Is cross-purchase better than entity redemption after Connelly?

Not automatically. Cross-purchase avoids the Connelly issue because the proceeds go to the surviving owners, not the company. But it means more policies as you add owners, and each owner pays premiums on the others. The right choice depends on the number of owners, your estate size and the tax picture, so decide it with your attorney and CPA.

How much life insurance do we need for a buy-sell?

Enough to buy each owner’s share at the value the agreement sets, and that value should be current. Coverage that was sized years ago against an old valuation is one of the most common gaps we find.

What if one partner can’t qualify for coverage?

The agreement can still work. Common alternatives include installment payments to the family, a reserve fund or a smaller policy combined with a note. An independent agent can also check more carriers before you settle for “uninsurable.”

Can we switch from entity redemption to cross-purchase?

Often, yes. But transferring existing policies can trigger the transfer-for-value rule, and new policies mean new underwriting. Plan it with your attorney first.

Fund it the right way

We’ll help you size coverage to your valuation, match ownership to your agreement’s structure, and compare options across many carriers. We coordinate with your attorney and CPA, who handle the legal and tax structure. Get a quote or call 586-343-1505.

This article is general information, not legal or tax advice. Buy-sell agreements should be drafted and reviewed by your own attorney and CPA.

Sources: Connelly v. United States, 602 U.S. 257 (2024), Supreme Court opinion; IRS, Estate Tax (filing thresholds); 26 U.S.C. §2703; 26 U.S.C. §101(a)(2) and §101(j); IRS Publication 551, Basis of Assets; IRS Form 8925 and instructions.