Cross-Purchase vs. Entity-Purchase Buy-Sell Agreements: How the Two Structures Compare

Short Answer: Which Structure Buys Out a Departing Owner's Interest?

In a cross-purchase buy-sell agreement, the surviving co-owners buy a deceased owner's interest themselves. In an entity-purchase agreement, also called a redemption, the business buys the interest back. Either can be funded with life insurance. The two differ in who owns the policies, who receives the proceeds, how many policies are needed and which federal tax rules apply.

Owners of closely held businesses usually weigh this when they decide how an ownership interest will change hands at an owner's death. The agreement is the plan; life insurance is one way to fund the purchase price it sets. The Supreme Court's 2024 decision in Connelly v. United States, 602 U.S. 257, addressed how insurance proceeds received by a corporation affect the estate-tax value of a deceased shareholder's shares. This page covers federal tax rules. State insurance and business-law rules vary by state.

At-a-Glance Comparison

The table compares the two structures on ten points.

The policy-count formula describes how each structure is built. It is not a coverage recommendation.

Option A: Cross-Purchase Agreements

A cross-purchase agreement is a contract among the owners. Each owner agrees to buy a deceased owner's interest. Each owner owns, pays for and is the beneficiary of a policy on each of the other owners. At a death, the survivors collect the proceeds and use them to buy the interest from the estate. The Court in Connelly described the arrangement in the same way: "shareholders agree to purchase each other's shares at death and purchase life-insurance policies on each other to fund the agreement" (602 U.S. 257). How the arrangement runs at death is the subject of a separate page on cross-purchase buy-sell agreements.

With n owners, and a separate policy held by each owner on each of the others, the structure needs n × (n − 1) policies. In a hypothetical business worth $3,000,000 with three equal owners, each interest is worth $1,000,000. That business needs 3 × 2 = 6 policies, and each owner holds two.

Income tax on the death benefit. Section 101(a)(1) 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." The exclusion has limits:

• Transfer for value. Under § 101(a)(2), when a policy is transferred "for a valuable consideration," the exclusion is generally limited to the consideration paid plus the premiums the new owner pays afterward.
• Exceptions. The transfer-for-value limit does not apply to a transfer (A) in which the transferee's basis in the contract is determined in whole or in part by reference to the transferor's basis, or (B) "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 co-shareholder of the insured is not on the (B) list.

Employer-owned contracts. Notice 2009-48, A-1, states that a contract "owned by the owner of an entity ... (such as for purposes of financing the purchase of an equity interest of another owner)" is not an employer-owned life insurance contract. As a result, the § 101(j) cap does not reach these owner-held policies.

Basis. A surviving owner who buys an interest generally has a cost basis in it that reflects the price paid. Cost basis is the tax measure used to compute gain on a later sale.

Estate tax. The business interest itself is part of the deceased owner's estate. The Court in Connelly observed that under a cross-purchase agreement the proceeds would have gone directly to a surviving shareholder rather than to the corporation. Section 2042 reaches insurance on the decedent's own life. Under 26 C.F.R. § 20.2042-1(a)(2), § 2042 "has no application" to the value of rights in a policy "on the life of a person other than the decedent." The policies the deceased owned on the surviving owners therefore raise a separate estate-inclusion question.

Transfers of policies, estate inclusion and valuation of the interest each turn on the facts and need individual review by the insurers involved and a qualified tax professional.

Option B: Entity-Purchase (Redemption) Agreements

An entity-purchase agreement is made between the business and its owners. The business owns, pays for and is the beneficiary of one policy on each owner. At a death, it collects the proceeds and redeems the deceased owner's interest from the estate. Connelly described this "share redemption agreement" as one that "contractually requires a corporation to repurchase a deceased shareholder's shares" (602 U.S. 257). The structure needs one policy per owner, however many owners there are.

Premiums. Section 264(a)(1) provides that no deduction is allowed for "premiums on any life insurance policy ... if the taxpayer is directly or indirectly a beneficiary under the policy." When the business pays the premiums and is the beneficiary, that rule applies to the business.

Income tax on the death benefit. Section 101(a)(1) generally excludes the proceeds from income, subject to the transfer-for-value rule in § 101(a)(2) and to § 101(j). Under § 101(j)(3)(A), an employer-owned contract is one owned by a person engaged in a trade or business that is a beneficiary and that covers an insured who is an employee when the contract is issued. Notice 2009-48 states, in A-3 and A-5:

• A-3: ownership "by a partnership or sole proprietorship does not prevent the contract" from being an employer-owned contract.
• A-5: the term "employee" "includes an officer, director, and highly compensated employee."

The § 101(j) cap. For an employer-owned contract, § 101(j)(1) caps the exclusion at "the sum of the premiums and other amounts paid." The cap is lifted only when two conditions are both met:

1. A § 101(j)(2) exception applies. One exception is based on the insured's status; the other covers amounts paid to the insured's heirs or used to buy their equity interest.
2. Written notice and consent under § 101(j)(4) were given "before the issuance of the contract."

An exception alone does not lift the cap, and neither do notice and consent alone. Separately, 26 U.S.C. § 6039I requires an annual return from a policyholder that owns employer-owned contracts, and Form 8925 describes what makes a consent valid. The § 101(j) analysis, Form 8925 reporting and premium deductibility for a particular contract need individual review by the insurers involved and a qualified tax professional.

Estate tax. In Connelly, the Court held that the corporation's "contractual obligation to redeem [the deceased shareholder's] shares did not diminish the value of those shares" (602 U.S. at 267). Because the corporation received the proceeds, the Court said the arrangement meant the corporation would "thereby increase the value of" the deceased shareholder's shares.

Basis. The surviving owners buy nothing in a redemption. Their percentage of ownership rises, but they do not acquire a new cost basis the way a direct purchase gives one.

Key Structural Differences

The differences start with who holds the contracts.

• Policy ownership and count. A cross-purchase multiplies the number of policies with each added owner. An entity-purchase adds one policy per owner.
• Premium payer. Individual owners pay in a cross-purchase; the business pays in an entity-purchase. That shifts premium cash flow from owners' personal funds to the business's funds. Section 264(a)(1) denies a premium deduction to whichever taxpayer is directly or indirectly a beneficiary, so it applies in both structures.
• Proceeds. The money goes to the individual owners in a cross-purchase and to the business in a redemption.

Connelly addressed this tradeoff directly. The Court said "the brothers could have used a cross-purchase agreement," then added, "But, every arrangement has its own drawbacks" (602 U.S. at 266–267). It noted that a cross-purchase "would have required each brother to pay the premiums for the insurance policy on the other brother, creating a risk that one of them would be unable to do so," and that "it would have had its own tax consequences."

Which structure fits a business is a legal and tax question. It depends on the entity type, the number of owners and the facts of the arrangement. A broader overview appears on the buy-sell life insurance page.

Tax Treatment Compared

Federal tax law treats the two structures differently in five areas.

Income tax on proceeds. In both structures, § 101(a)(1) generally excludes death proceeds from gross income. In both, § 101(a)(2) can limit the exclusion after a transfer for value. The § 101(a)(2)(B) exceptions name a partner of the insured, a partnership in which the insured is a partner, and a corporation in which the insured is a shareholder or officer. A co-shareholder is not named, so a corporate cross-purchase that moves policies between shareholders raises a transfer-for-value question.

Employer-owned contracts. Section 101(j) reaches a policy the business owns on an owner who is an employee. It does not reach a policy owned by an individual owner (Notice 2009-48, A-1). Where § 101(j) applies, the cap is lifted only if a § 101(j)(2) exception applies and written notice and consent preceded issue. Neither condition is automatic. Notice 2009-48, A-7, adds that a wholly owned corporation and its employee-owner are not excused from the notice and consent requirements.

Basis. Survivors who buy an interest directly generally hold a cost basis in what they bought. Survivors in a redemption do not. That difference may affect the gain on a later sale of the business.

Estate tax. For a redemption, Connelly held that the obligation to redeem did not reduce share value, and that proceeds received by the corporation increased it (602 U.S. at 267). Treasury regulations value stock by its selling prices "if there is a market for stocks or bonds" (26 C.F.R. § 20.2031-2(b)). Where actual sale prices and bona fide bid and asked prices are lacking, § 20.2031-2(f) has the fair market value of shares determined by considering factors that include "the company's net worth, prospective earning power and dividend-paying capacity, and other relevant factors," and it adds that "consideration shall also be given to nonoperating assets, including proceeds of life insurance policies payable to or for the benefit of the company," to the extent they have not already been taken into account in those factors. For a cross-purchase, § 2042 includes proceeds on the decedent's own life where the decedent held "any of the incidents of ownership." Under 26 C.F.R. § 20.2042-1(a)(2), § 2042 does not apply to policies the decedent owned on other people's lives.

Premiums. Section 264(a)(1) denies a deduction to a taxpayer that is directly or indirectly a beneficiary. That covers the business in a redemption and each owner in a cross-purchase.