Buy-Sell Agreement Funding
Buy-Sell Life Insurance for a C Corporation
Published October 9, 2026 · Updated October 9, 2026
Short Answer: How Life Insurance Funds a C Corporation Buy-Sell Agreement
For a C corporation, life insurance funds a buy-sell agreement by placing cash where the purchase obligation falls when a shareholder dies. In an entity purchase, the corporation owns policies on each shareholder and uses the proceeds to redeem the shares. In a cross-purchase, shareholders own policies on one another and buy the shares themselves. Each path carries different tax and estate consequences.
A C corporation buy-sell agreement is a binding contract that obligates the corporation or the remaining shareholders to buy a deceased shareholder's stock, and obligates the estate to sell. This page is written for shareholders of closely held C corporations and their finance leads. It explains both structures, the income-tax exclusion in section 101(a)(1), the employer-owned contract rules in section 101(j), estate inclusion under section 2042, and the Supreme Court's 2024 decision in Connelly v. United States. The general concept is explained on the site's page on buy-sell life insurance.
Why Buy-Sell Planning Matters for C Corporation Shareholders
Stock in a closely held C corporation has no public market. When a shareholder dies, the estate holds shares that may be hard to value and hard to sell, and the surviving shareholders may lack the cash to buy them.
Without a funded agreement, two outcomes are common: the estate sells to an outsider, or the heirs remain co-owners alongside people they did not choose to work with. A buy-sell agreement addresses both by fixing a price or a pricing method in advance, which narrows the room for disputes.
The agreement is the plan. Life insurance is one way to fund it, because the death benefit becomes payable at the event that triggers the purchase, without forcing the corporation or the survivors to sell operating assets.
How C Corporations Are Typically Structured for Buy-Sell Purposes
Unlike a partnership, a C corporation is a separate legal entity, and its owners hold stock rather than a direct interest in the business's assets.
Closely held C corporations often have a small group of shareholders who also work in the business as officers or employees. That overlap matters for the employer-owned contract rules.
Two ownership patterns follow. The corporation can own a policy on each shareholder as a corporate asset, which is an entity purchase. Each shareholder can instead own a policy on each co-shareholder, which is a cross-purchase. S corporations raise different issues and are covered on the site's S corporation buy-sell page.
The Triggering Events a C Corporation Buy-Sell Agreement Addresses
Death, disability, retirement and voluntary departure are the usual triggers written into a corporate buy-sell agreement. Life insurance funds only the death trigger; the other triggers are typically funded by other means, such as installment payments, and fall outside this page.
At a shareholder's death, the agreement obligates the buyer to purchase the decedent's shares at the agreed price or formula. The buyer is the corporation in a redemption, or the co-shareholders in a cross-purchase. The estate is obligated to sell, which keeps heirs from becoming unintended owners.
The funding gap is the practical risk. Without insurance, the buyer needs enough cash or credit on a date no one can predict. Valuation at the trigger is a separate issue: the agreement's price governs the sale between the parties, but for the estate tax a share redemption agreement is, in the words of the Connelly opinion, "ordinarily not dispositive for valuing the decedent's shares for the estate tax" (see section 2703).
How the Two Funding Structures Work in a C Corporation
The mechanics differ mainly in who sits on each side of the policy.
Entity purchase (stock redemption). The corporation applies for and owns a policy on each shareholder, pays the premiums and is the beneficiary. At a death, the corporation collects the proceeds and uses them to redeem the decedent's shares from the estate. The redeemed shares are no longer outstanding, so the survivors' percentage ownership rises.
Cross-purchase. Each shareholder owns a policy on each co-shareholder, pays its premiums and is its beneficiary. At a death, the survivors collect the proceeds and buy the decedent's shares directly from the estate. A buyer's cost basis in purchased shares is generally the price paid.
The policy count grows quickly in a cross-purchase. When each of N shareholders owns a separate policy on each of the others, the count is N × (N − 1): three shareholders give 3 × 2 = 6 policies, and four give 4 × 3 = 12.
Premiums are not deductible in either design. Section 264(a)(1) of the Internal Revenue Code provides that "No deduction shall be allowed for— (1) Premiums on any life insurance policy … if the taxpayer is directly or indirectly a beneficiary under the policy." The corporation is the beneficiary in a redemption, and each shareholder is the beneficiary in a cross-purchase. The site's page on buy-sell life insurance cost explains how structure shapes premium totals.
Policy Ownership and the Employer-Owned Life Insurance Rules
Section 101(a)(1) of the Internal Revenue Code provides that "gross income does not include amounts received … under a life insurance contract, if such amounts are paid by reason of the death of the insured," subject to listed exceptions that include the transfer-for-value rule and section 101(j).
Corporation-owned policies. A contract owned by a business that is its beneficiary, covering someone who is an employee when the contract is issued, is an employer-owned life insurance contract under section 101(j)(3). Section 101(j)(5)(A), which Notice 2009-48 A-5 restates, provides that "employee" "includes an officer, director, and highly compensated employee." Shareholders who serve as officers will often fall within that definition.
For such a contract, section 101(j)(1) limits the exclusion to "the sum of the premiums and other amounts paid by the policyholder for the contract." The limit is lifted only if a section 101(j)(2) exception applies and the section 101(j)(4) notice and consent were met before the contract was issued. Neither one alone is enough. The exceptions are:
- Insured's status: the insured was an employee at any time during the 12-month period before death, or at issue was a director, a highly compensated employee, or a highly compensated individual, each as defined for purposes of section 101(j)(2)(A).
- Heirs: amounts paid to the insured's family members, designated beneficiary, a trust for them or the estate, or used to buy an equity interest in the policyholder from such a person.
Notice and consent require that, before issue, the employee is told in writing of the intent to insure and the maximum face amount, gives written consent including to coverage continuing after employment ends, and is told in writing that the policyholder will be a beneficiary. Notice 2009-48 A-7 states that actual knowledge alone does not replace written notice, even for a wholly owned corporation. Section 6039I requires an annual return for employer-owned contracts issued after the section's enactment, filed on Form 8925, plus records.
Shareholder-owned policies. 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 purposes of financing the purchase of an equity interest of another owner)" is not an employer-owned contract.
Transfers. Under section 101(a)(2), a transfer of a policy for value generally limits the exclusion to the consideration plus later premiums. Section 101(a)(2)(B) excepts transfers to the insured, a partner of the insured, a partnership in which the insured is a partner, or "a corporation in which the insured is a shareholder or officer." A co-shareholder is not on that list. Section 101(j) compliance, Form 8925 reporting and any transfer of a policy between owners need individual review of the contracts involved by the insurers and a qualified tax professional.
Coverage and Funding Considerations for a C Corporation Buy-Sell
Sizing typically starts with the agreement's price. Each policy's face amount is commonly set near the insured shareholder's share of the agreed value, and as that value moves, owners often revisit coverage. The site's page on business valuation for buy-sell covers price clauses; valuation for buy-sell funding, and the estate-tax value of the shares under section 2703 and the Connelly decision, need individual review by the insurers, a qualified tax professional and a business valuator.
In a redemption, premiums are paid with corporate dollars and, under section 264(a)(1), are not deductible.
Insurer forms, underwriting, charges and procedures vary by insurer and are confirmed with the insurers involved. Insurance rules also vary by state.
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Who This Page Is For
This page addresses shareholders of closely held C corporations with two or more owners active in the business, owners comparing redemption and cross-purchase designs, and finance leads who want the federal rules in plain language.
It does not address S corporations, partnerships, LLCs or sole proprietorships, which turn on different rules. A corporation that already holds policies on shareholder-employees issued without written notice and consent faces a question that depends on its own facts; Notice 2009-48 A-13 describes relief for an inadvertent failure only where the policyholder made a good faith effort to satisfy the requirements and the failure was discovered and corrected no later than the due date of the tax return for the taxable year in which the contract was issued, and states that missing consent "cannot be corrected after the insured employee has died."
When a Life-Insurance-Funded Buy-Sell May Fit a C Corporation
A funded agreement is commonly considered when several facts line up:
- Two or more shareholders, where a death would leave the survivors or the estate short of cash.
- Shareholders who want the price or pricing method fixed in advance.
- Cash flow, at the corporation or among the shareholders, able to carry premiums over many years.
- A shared wish to keep ownership within the current group rather than passing it to heirs or outsiders.
- Shares with no ready market, so a prearranged exit has real value to the estate.
When a Life-Insurance-Funded Buy-Sell May Not Fit
Some facts make the design harder or less practical. A shareholder may be uninsurable or rated, leaving coverage unavailable or costly at the needed face amount. A business whose value swings widely makes it hard to keep face amounts aligned with the price.
A single-shareholder corporation has no co-owner to buy the shares; coverage on that owner is a key person question, explained on the site's key person insurance page.
In a cross-purchase, wide gaps in age or health mean a younger owner may pay much more to insure an older one. In a redemption, premiums are paid with after-tax corporate dollars, and whether a cross-purchase would be more efficient depends on facts this page does not have. The Connelly decision may also change how a redemption plays out for a deceased shareholder's estate.
Potential Advantages of a Funded Buy-Sell in a C Corporation
Liquidity is the central benefit: the death benefit arrives when the obligation is triggered, without a forced sale of operating assets.
Section 101(a)(1) generally excludes death benefits from the beneficiary's gross income. For a corporation-owned policy, that exclusion is limited by section 101(j) unless an exception applies and notice and consent were met. Notice 2009-48 A-1 states that a contract owned by the owner of an entity engaged in a trade or business, such as to finance the purchase of another owner's equity interest, is not an employer-owned contract; the transfer-for-value rule in section 101(a)(2) can apply to a transfer of a policy for value under either design.
In a cross-purchase, survivors generally take a cost basis in the purchased shares equal to the price paid, which may reduce gain on a later sale. A fixed or formula price narrows disputes, subject to section 2703. And because the estate must sell, outside ownership is kept out.
Important Considerations: Tax, Estate and Structural Issues
Premiums. Section 264(a)(1) bars a deduction for premiums when the taxpayer is directly or indirectly a beneficiary, which covers the corporation in a redemption and each shareholder in a cross-purchase.
Connelly v. United States (2024). In this estate tax valuation case the Supreme Court held that the contractual obligation of the corporation before it to redeem a decedent's shares "did not diminish the value of those shares," and that "redemption obligations are not necessarily liabilities that reduce a corporation's value for purposes of the federal estate tax." In that case the corporation had bought the life insurance policies and received the proceeds, and the Court said that arrangement meant the corporation would receive the proceeds and thereby increase the value of the shares. The opinion notes that a cross-purchase agreement would have avoided the risk that the insurance proceeds would increase the value of the shares, and that "every arrangement has its own drawbacks." The Court said it decided no more than that valuation question.
Section 2042. The gross estate includes proceeds receivable by the executor, and proceeds receivable by others when the decedent held "any of the incidents of ownership." Under 26 C.F.R. § 20.2042-1(c)(2), these include the power "to change the beneficiary, to surrender or cancel the policy, to assign the policy," to pledge it, or to borrow against it. If the decedent held none of these at death and did not transfer them in contemplation of death, paragraph (c)(1) of the regulation states that "no part of the proceeds would be includible" under section 2042. In a cross-purchase, the insured does not own the policy on his or her own life. Paragraph (c)(6) of the regulation provides that where the decedent is the sole or controlling stockholder, a corporation's incidents of ownership will not be attributed to the decedent through stock ownership to the extent the proceeds are payable to the corporation, and will be attributed as to any part of the proceeds not payable to or for the benefit of the corporation.
Section 2703. Under section 2703(a), the value of property is determined without regard to any option, agreement or other right to acquire the property at a price less than its fair market value, or any restriction on the right to sell or use it. Section 2703(b) provides that this rule does not apply to an option, agreement, right or restriction that 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."
Transfers. Moving a policy between shareholders for value after issue may trigger section 101(a)(2), because a co-shareholder is not a listed transferee, unless the carryover-basis exception in section 101(a)(2)(A) applies. A transfer to the corporation in which the insured is a shareholder or officer is excepted.
Alternatives to a Life-Insurance-Funded C Corporation Buy-Sell
Insurance is one funding source among several, each with limits. The site's page on buy-sell funding alternatives compares them.
- Installment note: the buyer pays the estate over time, creating years of payments and leaving the estate with a receivable instead of cash.
- Sinking fund: cash is set aside over time and may be too small if a death comes early.
- Bank financing: a loan funds the purchase, with payments due whatever the business's condition after the death.
Many agreements combine methods, such as insurance for death and notes for disability or retirement. Related topics include key person coverage and broader succession planning, explained on the site's business succession page.
Planning Example (Hypothetical): Redemption vs. Cross-Purchase in a C Corporation
This example is hypothetical. Assumptions: shareholders A and B each own 50% of a C corporation valued at $2,000,000, so each interest is $1,000,000. The agreement requires a purchase at that value. Premiums, taxes and policy terms are ignored.
Redemption (hypothetical).
- The corporation owns a $1,000,000 policy on each shareholder.
- A dies; the corporation receives $1,000,000. Its income-tax treatment turns on section 101(j) compliance.
- The corporation pays A's estate $1,000,000 and redeems A's shares.
- B owns 100%. B's basis in B's original shares is unchanged.
- If the Connelly holding applied to these assumptions, for estate-tax purposes the $1,000,000 of proceeds would count in the corporation's value and the redemption obligation would not offset it: $2,000,000 + $1,000,000 = $3,000,000, and 50% of that is $1,500,000, compared with the $1,000,000 price.
Cross-purchase (hypothetical).
- B owns a $1,000,000 policy on A.
- A dies; B receives $1,000,000. 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 purposes of financing the purchase of an equity interest of another owner, is not an employer-owned contract.
- B pays A's estate $1,000,000 for A's shares.
- B owns 100%, with a $1,000,000 cost basis in the acquired shares plus B's original basis.
Any reduction in gain on a later sale depends on B's original basis. This illustration shows mechanics only and does not represent any reader's result.
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Frequently Asked Questions
What are the four types of buy-sell agreements?
They are commonly described as entity purchase (redemption), cross-purchase, wait-and-see, and one-way. A wait-and-see agreement leaves the choice of buyer open until the trigger, and a one-way agreement binds a single owner's interest to a named buyer. These labels are industry terms, and this page focuses on redemption and cross-purchase in C corporations.
What is a disadvantage of a buy-sell agreement?
Funding costs are one, because section 264(a)(1) bars a premium deduction when the payer is a beneficiary. Coverage can also fall out of step with business value, and in Connelly, an estate tax valuation case, the corporation's receipt of the insurance proceeds increased the value of the decedent's shares. Ongoing maintenance and complexity add to the burden.
What is a buy-sell agreement for a business?
It is a binding contract among the owners that sets when an owner's interest must be sold and bought, such as at death, disability or departure. It fixes the price or the pricing method in advance and names the buyer.
What is another name for a buy-sell agreement?
It is also called a buyout agreement or a business continuation agreement. In a corporation, the terms often appear in a shareholder agreement or a stock purchase agreement.
What did Connelly v. United States decide about a corporation's redemption obligation?
The Supreme Court held that the contractual obligation of the corporation in that case to redeem a decedent's shares did not diminish the value of those shares for federal estate tax purposes. The corporation had received the life insurance proceeds, and the Court said that arrangement meant the proceeds increased the value of the shares. The Court decided only that valuation question, and its effect on a given agreement depends on the facts of that agreement.
Are life insurance proceeds taxable to a C corporation in a redemption buy-sell?
Section 101(a)(1) generally excludes death benefits from gross income, but section 101(j) limits the exclusion for employer-owned contracts to premiums and other amounts paid. The limit lifts only if a section 101(j)(2) exception applies and written notice and consent were given before issue. The transfer-for-value rule can also apply.
Educational information only. Not legal, tax, investment or insurance advice. Product availability and outcomes depend on individual circumstances.