Key takeaways
- Life insurance pays a lump-sum death benefit that can fund the purchase obligation a buy-sell agreement creates when an owner dies.
- In a cross-purchase, co-owners own policies on each other. In an entity purchase or redemption, the business owns a policy on each owner.
- Section 101(a)(1) of the Internal Revenue Code generally excludes from gross income amounts received under a life insurance contract that are paid by reason of the insured's death.
- The transfer-for-value rule in section 101(a)(2) can limit that exclusion when a policy changes hands for valuable consideration, and section 101(a)(2)(B) lists the transfers that are excepted.
- For employer-owned contracts, section 101(j) caps the exclusion at the premiums and other amounts paid. The cap lifts only when a statutory exception applies and written notice and consent were given before the contract was issued.
- IRS Notice 2009-48 states that a contract owned by an owner of an entity, for example to finance buying another owner's interest, is not an employer-owned life insurance contract.
- Section 264(a)(1) allows no deduction for premiums when the taxpayer is directly or indirectly a beneficiary under the policy. That describes both buy-sell structures.
Published October 6, 2026 · Updated October 8, 2026
Short Answer: What Buy-Sell Life Insurance Does
Buy-sell life insurance is life insurance bought to fund a buy-sell agreement. Under that contract, the remaining owners or the business itself agree to buy a deceased owner's interest, and the owner's estate agrees to sell. At death, the policy's death benefit supplies the cash for the purchase, so the heirs receive money and the interest passes to the buyers.
The reader in this position is usually a co-owner of a closely held company, a partner in a firm or a shareholder in a corporation. That owner has accepted that a business interest is hard to sell on short notice and wants to know how the purchase would be paid for. A buy-sell agreement is a legally binding contract among the owners. It obligates the surviving or remaining owners, or the entity, to buy a departing owner's interest when a stated event occurs, and it obligates the owner or the estate to sell.
The agreement itself is drafted by legal counsel. Business Life Insurance treats it as the business plan and treats life insurance as one way to fund it. The funding takes one of two main shapes: a cross-purchase, in which the owners insure one another, or an entity purchase, also called a redemption, in which the business insures each owner. Both rest on the same federal rules for owners, premiums, beneficiaries and death benefits.
How a Life-Insurance-Funded Buy-Sell Agreement Works
Every buy-sell arrangement starts with the same business problem. When an owner of a closely held company dies, the owner's interest passes to an estate or to heirs who may not want to run the business, and the surviving owners may not want them as partners. There is rarely an outside market for a minority stake in a private company. Without a plan, the parties are left to negotiate price, timing and payment after the death, when the cash and the agreed terms may both be missing.
The triggering event
A buy-sell agreement names the events that set the purchase in motion. Death is the event life insurance is designed to fund. Agreements often also address disability, retirement or withdrawal, but a death benefit pays only on death, so those other triggers are usually funded in other ways.
The price, set in advance
The agreement fixes the purchase price, or a formula or appraisal method for finding it, before any owner dies. That advance agreement is what lets an insurance amount be chosen. Without it, nothing tells the owners how much coverage the obligation calls for.
The flow of money and ownership
When the insured owner dies, the insurer pays the death benefit to the policy's beneficiary. Depending on the structure, that is the surviving owners or the business entity. The beneficiary uses the proceeds to pay the estate or heirs the agreed price. The heirs receive cash and give up the business interest, and the buyers receive the interest. The agreement and the policies work as a pair: the face amount, meaning the death benefit stated in the policy, is set with the agreed price in mind, and both are revisited as the business's value changes.
Counsel drafts the agreement's terms. Business Life Insurance explains the insurance layer underneath them. For the broader ways companies use coverage, the site's overview of business life insurance covers the full landscape.
Who This Arrangement Is For
Buy and sell life insurance is relevant mainly to businesses with two or more owners whose interests are defined. That includes partnerships, LLCs, S corporations, C corporations and professional practices. The federal rules turn partly on the business form. A transfer of a policy to a partner of the insured, for example, is treated differently from a transfer to a co-shareholder. How the arrangement fits an LLC is covered on the site's LLC buy-sell page. A practice-specific view is on the page about life insurance for law firms. Professional-licensing rules on who may own a practice interest vary by state.
The people the arrangement serves fall into three groups:
- Surviving owners who want the business to keep operating without a forced sale to an outsider or a new co-owner they did not choose.
- The deceased owner's estate and heirs, who often need cash rather than an illiquid business interest.
- The business itself, whose customers, lenders and employees depend on settled ownership.
The arrangement is less relevant to a sole proprietor, because there is no co-owner to act as buyer. It is also less relevant where the owners have no agreed valuation method, because the insurance has no price to match. A business mainly concerned with losing a critical person's skills, rather than with ownership, is usually looking at key person coverage, a separate strategy with its own page on the site.
When a Life-Insurance-Funded Buy-Sell May Fit
The arrangement is commonly used where several facts line up:
- The owners are insurable. Each can obtain coverage at premiums the co-owners or the business can sustain over the life of the arrangement.
- The business has a definable value. That value can be translated into a face amount on each owner's life.
- The owners want a known buyer. Rather than leave the estate to find a purchaser after a death, they want the agreement and the policy to supply one.
- The business depends on its owners. A forced outside sale or an unwanted co-owner would disrupt operations, client relationships or credit.
- The terms are already agreed. The owners have settled the structure, the valuation method and the triggering events before any policy is applied for.
None of these facts makes the arrangement suitable for a given business. The decision generally turns on how the owners weigh cost, certainty and administration against the other ways of funding the same obligation.
When a Life-Insurance-Funded Buy-Sell May Not Fit
The opposite facts point the other way:
- An owner is uninsurable, or the quoted premiums make coverage on one or more lives impractical.
- The business's value is volatile or hard to establish, so no face amount stays in step with the price for long.
- There are many owners. A cross-purchase then needs many separate policies, and administration grows quickly.
- Cash flow is thin. The owners or the business cannot sustain the premiums year after year.
- The owners cannot agree on a price or valuation method. That agreement comes before any funding, insured or not.
Where these conditions hold, owners typically look at other funding methods. The site's funding page compares life insurance with those alternatives.
Ownership, Premiums and Beneficiary Mechanics
Ownership is the fact everything else depends on. Who owns each policy decides who pays, who collects and which tax rules come into play.
Cross-purchase
Each co-owner applies for and owns a policy on each other co-owner's life. The owner of each policy pays its premiums and is named as its beneficiary. At a death, each surviving owner collects on the policy covering the deceased owner and uses the proceeds to buy a share of that owner's interest. The site's page on cross-purchase buy-sell agreements walks through this structure in detail.
The number of policies rises quickly. With N owners, each owner insures every other owner, so the count is N × (N − 1). Two owners need 2 policies. Four owners need 4 × 3 = 12. Six owners need 6 × 5 = 30.
Entity purchase (redemption)
The business owns one policy on each owner's life, pays the premiums and is the beneficiary. At a death, the entity collects the death benefit and uses it to redeem, meaning buy back and retire, the deceased owner's interest from the estate. The number of policies equals the number of owners.
Premiums and section 264(a)(1)
Premiums in either structure meet the same federal limit. Section 264(a)(1) of the Internal Revenue Code provides that "No deduction shall be allowed for— (1) Premiums on any life insurance policy, or endowment or annuity contract, if the taxpayer is directly or indirectly a beneficiary under the policy or contract." In an entity purchase, the business pays and the business is the beneficiary. In a cross-purchase, each owner pays and that owner is the beneficiary. In both, the payer is generally a beneficiary, so the rule generally bars a deduction. The site explains the same rule in the key person setting on its page about the tax treatment of key person insurance premiums.
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Federal Tax Treatment of the Death Benefit
The federal starting point is an exclusion. Section 101(a)(1) of the Internal Revenue Code provides that, except as otherwise provided in later paragraphs and subsections, "gross income does not include amounts received (whether in a single sum or otherwise) under a life insurance contract, if such amounts are paid by reason of the death of the insured." In plain terms, a beneficiary generally does not report a death benefit as income. That word "generally" carries two limits that matter in buy-sell planning: the transfer-for-value rule and the rules for employer-owned contracts.
The transfer-for-value rule
Section 101(a)(2) addresses a policy that changes hands for something of value. It provides that, for "a transfer for a valuable consideration, by assignment or otherwise, of a life insurance contract or any interest therein, the amount excluded from gross income by paragraph (1) shall not exceed an amount equal to the sum of the actual value of such consideration and the premiums and other amounts subsequently paid by the transferee." Any death benefit above that sum may then be income to the new owner. The Treasury regulation, 26 C.F.R. § 1.101-1, illustrates the rule. In its Example 1, an insured sells a $100,000 policy to the insured's child for $6,000. The child's exclusion is limited to $6,000 plus the premiums and other amounts the child pays after the transfer.
The statute lists two kinds of transfers to which this limit does not apply. The first is a transfer in which the new owner's basis is determined in whole or in part by reference to the prior owner's basis. The second, in section 101(a)(2)(B), is a transfer "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." Section 101(a)(3) provides that the second sentence of paragraph (2), which contains these two exceptions, does not apply to a transfer that is a "reportable policy sale." Section 101(a)(3)(B) defines that term as an acquisition of an interest in a life insurance contract by an acquirer with "no substantial family, business, or financial relationship with the insured apart from the acquirer's interest in such life insurance contract." Sales of policies to third parties fall outside this site's scope.
The co-shareholder trap
The section 101(a)(2)(B) list has a gap that matters to corporations. It includes a partner of the insured and a corporation in which the insured is a shareholder or officer. It does not include a fellow shareholder of the insured. Suppose three shareholders of a corporation hold cross-purchase policies on one another, and one dies. If a surviving shareholder buys from the deceased shareholder's estate the policy the deceased held on the other survivor's life, that is a transfer for value to a co-shareholder of the insured, and the listed exceptions do not name it. A transfer to the insured is on the list. The same gap can arise when a corporation moves from an entity purchase to a cross-purchase by selling its policies to the shareholders. A transfer to the corporation, by contrast, is on the list. Partnerships are treated differently, because a partner of the insured is named.
Employer-owned life insurance: section 101(j)
Section 101(j) adds a second limit for an "employer-owned life insurance contract." Section 101(j)(3)(A) defines it as a contract owned by a person engaged in a trade or business, under which that person, or a related person, "is directly or indirectly a beneficiary," and which covers an insured who is an employee of that trade or business on the date the contract is issued. Section 101(j)(5)(A) provides that "employee" includes an officer, director and highly compensated employee. Notice 2009-48, A-5, adds that "A director is an independent contractor in his or her capacity as a director."
For these contracts, section 101(j)(1) provides that the excluded amount "shall not exceed an amount equal to the sum of the premiums and other amounts paid by the policyholder for the contract." The cap lifts only if two conditions are both met. The first is that an exception in section 101(j)(2) applies. One kind of exception turns on the insured's status: an employee at any time during the 12-month period before death, or, at the time the contract is issued, a director, a highly compensated employee or a highly compensated individual, each as the statute defines them. The other kind covers amounts paid to the insured's family members, designated beneficiary, a trust for them or the insured's estate. It also covers amounts "used to purchase an equity (or capital or profits) interest in the applicable policyholder from any" of those persons. That last exception is the one that speaks directly to a redemption. The second condition is that the notice and consent requirements of section 101(j)(4) are met "before the issuance of the contract." Under those requirements, the employee is notified in writing that the policyholder intends to insure the employee's life and of the maximum face amount. The employee also gives written consent to being insured, including that coverage may continue after employment ends, and is informed in writing that the policyholder will be a beneficiary. An exception without timely notice and consent does not lift the cap, and neither does notice and consent without an exception.
Notice 2009-48 adds several points. A-7 states that no exception excuses "a wholly-owned corporation and its employee-owner" from notice and consent, and that actual knowledge cannot substitute for writing. A-13 states that section 101(j) "does not contain a provision for correcting an inadvertent failure." It describes conditions under which the IRS will not challenge an exception despite such a failure, and it notes that missing consent "cannot be corrected after the insured employee has died." A-3 states that, if a life insurance contract is otherwise described in section 101(j)(3), "ownership of the contract by a partnership or sole proprietorship does not prevent the contract from being treated as an employer-owned life insurance contract." Finally, A-1 states that "a contract that is owned by the owner of an entity engaged in a trade or business (such as for purposes of financing the purchase of an equity interest of another owner) ... is not an employer-owned life insurance contract." Owner-held cross-purchase policies therefore sit outside section 101(j), and entity-owned redemption policies generally sit inside it.
Reporting
Section 6039I requires every applicable policyholder owning employer-owned life insurance contracts issued after August 17, 2006, to file a return for each year the contracts are owned, showing the number of employees, the number insured, the insurance in force and whether valid consents were obtained. The IRS form used for this return is Form 8925.
Whether a given transfer is a transfer for value, whether notice and consent were met, and whether premiums are deductible each need individual review of the contracts involved by qualified tax, legal and insurance professionals.
What Affects the Amount of Coverage and Its Cost
The face amount follows the agreement. The insurance is sized to the price or valuation formula the owners have adopted, and the insurer does not set that price.
Valuation drives the face amount
Agreements use various valuation approaches. These include a fixed agreed value that the owners update periodically, a formula tied to book value or earnings, or an appraisal at the time of the triggering event. Each produces a different number, and each moves differently as the business grows or contracts. A formula or appraisal price can drift away from a fixed face amount over time. The way an agreement handles that gap, through a cash top-up, a promissory note for the balance or periodic coverage reviews, is a drafting question for counsel. How the business is valued for this purpose also turns on its own facts.
What drives premiums
Premium cost depends on the insured's age and health, the face amount, and the type of policy. Term insurance covers a stated period. Permanent coverage is designed to last for life and carries a cash value, an accumulated amount inside the contract that is a feature of the policy. The choice of type affects cost. It also affects what happens if an owner outlives a term period while the agreement is still in force. That is a planning trade-off, not a matter with one answer. In a cross-purchase, the number of owners multiplies the number of policies, and an older or less healthy owner's coverage may cost the younger co-owner who buys it more than the reverse. Underwriting standards, application forms and premium rates vary from insurer to insurer and are confirmed with the insurers involved.
Common Structures: Cross-Purchase and Entity Purchase
Two designs account for most arrangements, and a few practical and tax differences separate them.
Cross-purchase
Each owner owns, pays for and is beneficiary of a policy on each other owner. At a death, the survivors collect the death benefit and buy the deceased owner's interest directly from the estate. Notice 2009-48, A-1, states that a contract owned by the owner of an entity engaged in a trade or business, such as for financing the purchase of another owner's equity interest, is not an employer-owned life insurance contract. In general terms, a buyer's basis in purchased property starts from the price paid, so each survivor's basis in the newly bought interest reflects what that survivor paid. The main risks are the number of policies and, in a corporation, the co-shareholder gap in the transfer-for-value exceptions.
Entity purchase (redemption)
The business owns, pays for and is beneficiary of a policy on each owner. At a death, the entity collects the death benefit and redeems the interest from the estate. The surviving owners end up owning the whole business without buying anything themselves. Because the business owns the policies and benefits from them, section 101(j) and its notice-and-consent rules generally apply.
What Connelly decided about redemptions
In Connelly v. United States (2024), the Supreme Court described a share redemption agreement as one that "contractually requires a corporation to repurchase a deceased shareholder's shares." It held, for federal estate-tax purposes, that the corporation's "contractual obligation to redeem [the deceased shareholder's] shares did not diminish the value of those shares." The Court noted that a cross-purchase agreement would have sent the proceeds directly to the surviving shareholder rather than to the corporation, and also that such an agreement "would have required each [shareholder] to pay the premiums for the insurance policy on the other [shareholder], creating a risk that one of them would be unable to do so." The opinion decided that one valuation question on its facts. It says nothing about income tax, section 101(j) or transfer for value.
A side-by-side comparison of the two designs is on the site's cross-purchase versus entity purchase page.
Potential Advantages of Life-Insurance Funding
The advantages come from the mechanics, and each depends on the policy staying in force.
- Cash at the moment it is needed. The death benefit arrives because of the same event that creates the purchase obligation, rather than having to be raised afterward.
- A known amount. The face amount is fixed in the contract, so the owners can set a price knowing what funds the policy is designed to deliver, as long as premiums are paid.
- An income-tax exclusion under the statute. Section 101(a)(1) generally excludes the death benefit from gross income, subject to the transfer-for-value and employer-owned contract limits that apply to these arrangements.
- Continuity. The surviving owners or the business can complete the purchase without selling the company or taking in an outside owner.
- A ready market. The agreement and the policy together create a buyer and a source of payment for an interest that otherwise has none.
- Cash value as a contract feature. Permanent policies carry a cash value that some arrangements look to for a lifetime trigger such as retirement. Access to it affects the policy and the death benefit, and the terms vary by contract.
Important Considerations and Risks
The costs and limits are as concrete as the advantages.
- No premium deduction. Section 264(a)(1) generally bars a deduction when the payer is directly or indirectly a beneficiary. That describes both the entity in a redemption and the owner in a cross-purchase.
- Restructuring and transfer for value. Adding or removing owners, or moving from an entity purchase to a cross-purchase, often involves moving existing policies. Under section 101(a)(2), a transfer for valuable consideration outside the listed exceptions may limit the exclusion.
- Employer-owned contract compliance. Entity-owned policies on employees are subject to annual reporting under section 6039I. Under section 101(j), the exclusion can be capped at the premiums paid unless written notice and consent were given before issuance and an applicable exception applies.
- Valuation drift. If the face amount does not match the price at death, the buyers may be short of cash or the proceeds may exceed the price. Agreements commonly provide for periodic review.
- Insurability. An owner who becomes uninsurable cannot be covered, which leaves that owner's interest unfunded.
- Lapse. If premiums stop and a policy lapses, the funding disappears. The Connelly opinion pointed to this concern in a cross-purchase, where each owner pays separately.
- Estate-tax value. Section 2703 provides that, for estate-tax purposes, value is determined "without regard to" an option or agreement to acquire property "at a price less than the fair market value" or any restriction on sale. The exception applies only if the agreement meets each of three requirements: it is "a bona fide business arrangement"; it is "not a device to transfer such property to members of the decedent's family for less than full and adequate consideration"; and its "terms are comparable to similar arrangements entered into by persons in an arms' length transaction." Connelly noted that a share redemption agreement may delineate how to set a price for the shares but "is ordinarily not dispositive for valuing the decedent's shares for the estate tax."
Business valuation for buy-sell funding and the section 2703 analysis need individual review by qualified tax, legal and insurance professionals.
Alternatives to Life-Insurance Funding
Insurance is one way to fund a buy-sell obligation, not the only one. The main alternatives are:
- A sinking fund. The business or the owners set cash aside over time. There is no lump sum if a death comes early.
- An installment purchase. The buyers pay the estate over years after the death, which creates an ongoing payment obligation and leaves the estate as a creditor.
- Third-party financing. The buyers borrow to pay the price, which adds debt and interest to the business at a difficult time.
Each carries a different cash-flow, tax and risk profile. The comparison among them is on the site's buy-sell funding page. Business Life Insurance covers the insurance-funded arrangement here.
Hypothetical Example: A Two-Owner Cross-Purchase
This example is hypothetical. It uses round figures to show the mechanics and says nothing about any reader's business or contracts.
Assumptions (hypothetical):
- Owners A and B each own half of a business valued at $2,000,000.
- Each half interest is therefore worth $2,000,000 ÷ 2 = $1,000,000.
- The agreement is a cross-purchase at that price.
- Owner A owns a $1,000,000 policy on Owner B and is its beneficiary. Owner B owns a $1,000,000 policy on Owner A and is its beneficiary.
- By assumption, neither policy was ever transferred for value, and each is owned by an owner of the business. Notice 2009-48, A-1, states that a contract owned by the owner of an entity engaged in a trade or business is not an employer-owned life insurance contract.
- The business's value is unchanged at the date of death.
Step 1. Owner A dies. Owner B, as beneficiary, receives $1,000,000. On these assumptions, section 101(a)(1) generally excludes that amount from Owner B's gross income.
Step 2. As the agreement requires, Owner B pays Owner A's estate $1,000,000 for Owner A's half.
Step 3. The estate holds $1,000,000 in cash. Owner B owns 50% + 50% = 100% of the business.
Step 4. Owner B paid $1,000,000 for the acquired half. In general terms, that price is the starting point for Owner B's basis in that half. Basis matters if Owner B later sells, and how it applies turns on the facts of that sale.
Notes. Over the years before the death, each owner paid premiums on the policy he or she owned. Under section 264(a)(1), those premiums were generally not deductible, because each payer was the beneficiary. If the business had grown to $3,000,000, each half would be worth $3,000,000 ÷ 2 = $1,500,000. The $1,000,000 policy would then leave $1,500,000 − $1,000,000 = $500,000 for the agreement to cover in some other way.
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Frequently Asked Questions
What is the purpose of a buy-sell agreement?
A buy-sell agreement creates a committed buyer and a set price for an owner's interest when a named event occurs. It binds the remaining owners or the entity to buy, and the owner or estate to sell, on terms fixed in advance. That gives an otherwise illiquid interest a market. The agreement is drafted by legal counsel.
Who is the beneficiary of a life insurance policy in a buy-sell agreement?
The beneficiary follows the structure. In a cross-purchase, each co-owner is the beneficiary of the policy he or she owns on the other owners. In an entity purchase, the business is the beneficiary of the policy on each owner.
Are life insurance death benefits received under a buy-sell arrangement taxable income?
Section 101(a)(1) of the Internal Revenue Code generally excludes from gross income amounts paid under a life insurance contract by reason of the insured's death. Two limits apply. Section 101(a)(2) can reduce the exclusion after a transfer for value. Section 101(j) caps it for employer-owned contracts unless an exception applies and written notice and consent were given before issuance.
What is the transfer-for-value rule and why does it matter for buy-sell planning?
Under section 101(a)(2), when a policy is transferred for valuable consideration, the exclusion is limited to the consideration paid plus the premiums and other amounts the new owner pays afterward. Buy-sell plans move policies when owners join or leave or when the structure changes. Each such move may be a transfer for value unless an exception fits.
What are the exceptions to the transfer-for-value rule that apply in buy-sell planning?
Section 101(a)(2)(B) excepts a transfer to the insured, to a partner of the insured, to a partnership in which the insured is a partner, and to a corporation in which the insured is a shareholder or officer. Section 101(a)(2) also excepts a transfer in which the new owner's basis carries over from the prior owner's basis. A transfer to a fellow shareholder of the insured is not on the list.
What are the disadvantages of a buy-sell agreement funded with life insurance?
The main drawbacks are cost and upkeep. Premiums are generally not deductible under section 264(a)(1). Coverage can fall out of step with the business's value. An uninsurable owner cannot be covered, and a lapsed policy leaves the purchase unfunded. Restructuring can also raise transfer-for-value questions.
Does section 101(j) apply to policies owned by individual owners in a cross-purchase buy-sell?
IRS Notice 2009-48, A-1, states that a contract owned by the owner of an entity, such as to finance buying another owner's interest, is not an employer-owned life insurance contract. Section 101(j) is therefore mainly a concern when the business itself owns the policies.
Can a buy-sell agreement fix the estate-tax value of a business interest?
Not automatically. Section 2703(a) determines value without regard to an agreement to acquire property at a price less than fair market value, or a restriction on sale, unless the agreement is a bona fide business arrangement, is not a device to transfer property to family for less than full consideration, and has terms comparable to arm's-length arrangements. Whether an agreement meets those tests turns on its facts.
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