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

Buy-sell agreement life insurance is coverage on each business owner that pays for a buyout when an owner dies. The agreement sets the price and the buyer; the insurance supplies the cash. The family gets paid a fair price, and the surviving owners keep the business.

There are two main ways to set it up. In a cross-purchase plan, the owners buy policies on each other. In an entity redemption plan, the business owns the policies and buys back the shares. In 2024, the Supreme Court ruled in Connelly v. United States that insurance paid to a corporation for a redemption can increase the estate-tax value of the deceased owner's shares. That makes the choice of structure more important. This guide is general information, not legal or tax advice.

What is a buy-sell agreement?

It is a contract among the owners of a business that decides what happens to an owner's share when certain events occur. A typical agreement answers four questions:

1. Triggers. Which events start a sale: death, disability, retirement, divorce, or an owner wanting out.
2. Buyer. Whether the other owners, the business, or a mix must or may buy.
3. Price. A fixed price, a formula, or an outside appraisal, and how often it is updated.
4. Funding. How the buyer will pay, often life insurance for the death trigger.

For small companies, it also keeps ownership stable. The U.S. Small Business Administration notes that in some states an LLC may have to dissolve and re-form when a member leaves, "unless there's already an agreement in place within the LLC for buying, selling, and transferring ownership."

How does life insurance fund a buy-sell agreement?

Each owner is insured for roughly the value of their share. When an owner dies, the policy pays the buyer, and the buyer pays the family for the share.

Without insurance, surviving owners often have to borrow, sell assets or pay the family in installments over years. With it, the cash comes from the policy once the claim is paid. The family receives a set price instead of an ownership stake in a business they may not want to run.

Cross-purchase vs. entity redemption: what's the difference?

The difference is who owns the policies and who buys the shares.

Two rows in that table come straight from primary sources. The Supreme Court in Connelly described the premium risk of cross-purchase plans. IRS Notice 2009-48 says a policy owned by a business owner personally to fund the purchase of another owner's interest is not an employer-owned life insurance contract. When the business owns the policies, the section 101(j) notice and consent rules apply, as explained in our guide to key person life insurance. One of the 101(j) exceptions covers proceeds used to buy an ownership interest from the insured's family or heirs.

The two structures can also leave the surviving owners with different tax basis in their shares, which matters if they later sell. Ask your CPA to compare both for your business.

What did Connelly v. United States decide?

The Court held that a corporation's contractual obligation to redeem shares at fair market value is not necessarily a liability that reduces the corporation's value for federal estate tax. The decision in Connelly v. United States, No. 23-146, came down on June 6, 2024. Justice Thomas wrote for a unanimous Court.

The facts, as the opinion describes them:

• Brothers Michael and Thomas Connelly were the only shareholders of a building supply corporation. Michael owned 77.18%.
• Their agreement gave the surviving brother the option to buy a deceased brother's shares. If he declined, the corporation had to redeem them.
• The corporation bought $3.5 million of life insurance on each brother.
• After Michael died in 2013, Thomas declined to buy. The corporation paid Michael's estate $3 million, the value the family agreed on.
• The IRS counted the $3 million of insurance proceeds as a company asset. It valued the company at $6.86 million and Michael's shares at about $5.3 million, then assessed $889,914 in additional estate tax.

The Court agreed with the IRS. Its reasoning: at the moment of death, a buyer of Michael's shares would get a stake in a company holding the insurance money, so the proceeds count. The Court said the brothers "could have used a cross-purchase agreement," in which the proceeds "would have gone directly to Thomas—not to Crown." It also noted that cross-purchase plans have drawbacks, including the risk that one owner can't pay premiums.

The Court added a limit in a footnote. It did not hold that a redemption obligation can never reduce a company's value, for example if paying for the shares forced the sale of operating assets.

Does Connelly matter if your estate is below the exemption?

Usually less. The IRS's estate and gift tax page lists the basic exclusion amount as $15,000,000 for deaths in 2026, up from $13,990,000 in 2025. If an owner's total estate, including the business stake with insurance proceeds counted, stays well below that, the Connelly valuation issue may not change the tax bill.

It still matters in three situations:

• Growing companies. Today's small business can be worth far more by the time an owner dies.
• State estate taxes. Some states have their own estate or inheritance taxes with lower thresholds.
• Price disputes. Connelly also shows what happens when owners agree on a price informally instead of following the agreement's valuation method. The IRS and the courts looked past the $3 million price the family had agreed on.

How much buy-sell life insurance do you need?

Enough to cover each owner's share at its current value, updated on a schedule. Start with a recent valuation, then insure each owner for their percentage of it.

The Court's own example shows why the math matters. In a company holding $10 million with owners A (80 shares) and B (20 shares), each share is worth $100,000, so buying out B costs $2 million. If a company-owned policy on B would add to company value at B's death, a redemption plan may need more coverage to pay a fair-market price. The Court acknowledged the point. When Thomas argued that Crown "would have needed an insurance policy worth far more than $3 million" to redeem Michael's shares at fair market value, the Court answered, "True enough."

Practical steps:

1. Get a valuation and write the method into the agreement.
2. Update the valuation every year or two, and after big changes.
3. Adjust coverage when the value changes.
4. Decide what happens if the payout falls short, such as a promissory note for the gap.

Can you switch from redemption to cross-purchase?

Often, yes, but moving existing policies needs care. Under 26 U.S.C. § 101(a)(2), a policy transferred "for a valuable consideration" can lose part of its income-tax-free status. The law excepts transfers to the insured, to a partner of the insured, to a partnership in which the insured is a partner, or to a corporation in which the insured is a shareholder or officer. A sale of a corporate-owned policy to a fellow shareholder is not on that list.

Because of that, some owners buy new policies instead of moving old ones, and others set up partnership or LLC arrangements. Every route has tax and legal consequences, so work through it with a tax professional and a business attorney before changing anything.

How do you set up a funded buy-sell agreement?

1. Meet with a business attorney to draft or review the agreement.
2. Ask a CPA to compare cross-purchase, redemption and hybrid structures for your business, your state and your estate sizes.
3. Get a business valuation.
4. Apply for coverage on each owner. If the business will own the policies, complete the section 101(j) notice and consent forms before the policies are issued.
5. Keep the agreement, valuation and coverage in sync every year.

For the personal side of coverage, see our pillar guide to life insurance for self-employed people, or browse the self-employed life insurance hub.