Buy-Sell Insurance With Three or More Owners: How the Structure Works

Short Answer: Life Insurance and a Three-or-More-Owner Buy-Sell

For a business with three or more owners, life insurance can fund a buy-sell agreement. However, the number of owners changes the mechanics. In a cross-purchase, each owner holds a policy on every other owner, so the number of policies grows quickly. In an entity-purchase, also called a redemption, the business holds one policy per owner.

This page is written for co-owners and finance leads of closely held companies that have three or more owners. It covers only the multi-owner buy-sell structure. Business Life Insurance treats two-owner, partnership, LLC, S corporation and redemption arrangements on their own pages. The general topic is introduced on the page about buy-sell life insurance.

Why Owner Count Changes the Buy-Sell Structure

The difference is arithmetic. In a cross-purchase, each owner insures every other owner. With N owners, each owner holds N − 1 policies, and the total is N × (N − 1):

• 3 owners: 3 × 2 = 6 policies
• 4 owners: 4 × 3 = 12 policies
• 5 owners: 5 × 4 = 20 policies

An entity-purchase needs only N policies.

The choice of structure determines several things:

• who owns each policy,
• who pays the premiums,
• who is named as beneficiary, and
• how the death proceeds are treated for income tax.

Under 26 U.S.C. § 101(a)(1), gross income generally "does not include amounts received ... under a life insurance contract, if such amounts are paid by reason of the death of the insured."

A separate concern arises when owners reassign policies among themselves, for example after an owner leaves. In that case, the transfer-for-value rule in § 101(a)(2) can limit the exclusion.

Topics on this page need individual review of the contracts involved by the insurers and a qualified tax professional. These topics are:

• transfer for value,
• employer-owned contract notice and consent,
• business valuation,
• estate-tax valuation, and
• trust-held arrangements.

The entity form also matters, whether a partnership, an LLC, an S corporation or a C corporation. Each form has its own page on this site.

How Closely Held Businesses With Multiple Owners Are Typically Structured

This page concerns a closely held business with three or more owners, where each owner holds an interest and there is no public market where an owner's interest could be sold.

Without an agreement, the remaining owners may have no say in who holds a deceased or departing owner's interest. A buy-sell agreement addresses this. It is a contract among the owners that may set out the terms of a transfer, a price or a method for setting the price, and the events that trigger it, such as death.

Life insurance is one way to fund the buyout that the death trigger requires, and it is the mechanism this page discusses. Setting the price is a separate question, covered on the page about business valuation for buy-sell.

The Death Trigger: What Happens When One of Several Owners Dies

When one owner dies, two parties face a cash problem at the same time:

• The surviving owners need cash to buy the deceased owner's interest from the estate at the agreed price.
• The estate needs cash, or at least a liquid asset, rather than a minority stake in a private company.

If the buyout is not funded, the survivors may have to borrow, sell business assets, or accept the heirs as new co-owners.

The estate may also need a value for the interest for federal estate tax. The agreement's price does not automatically control that value. In Connelly v. United States, 602 U.S. 257 (2024), the Supreme Court held that a corporation's contractual obligation to redeem a deceased shareholder's shares did not diminish the value of those shares for the federal estate tax; the corporation there owned the life insurance on its shareholders. Under 26 U.S.C. § 2703(a), value is generally determined "without regard to" an option or agreement to buy at less than fair market value. The exception in § 2703(b) applies only if the arrangement meets all three of these 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."

The proceeds themselves are generally excluded from the beneficiary's gross income under § 101(a)(1). That exclusion is subject to the transfer-for-value limit and the employer-owned contract limit, both explained in the following section.

How the Two Main Structures Work With Three or More Owners

Cross-purchase. Each owner owns, pays for and is the beneficiary of a policy on each of the other owners. When an owner dies, the surviving owners collect the proceeds. They then use the proceeds to buy the deceased owner's interest from the estate. In general, a buyer's basis reflects the price paid. Basis is the figure used to measure gain on a later sale, so a higher basis means less gain. How basis is computed depends on the entity form and the facts.

Entity-purchase (redemption). The business owns one policy per owner, pays the premiums and is the beneficiary. When an owner dies, the business collects the proceeds and redeems, meaning buys back, the deceased owner's interest. The survivors' percentage interests increase, but they have bought nothing directly. As a result, no purchase-price basis generally arises for them.

Premium deductibility. Section 264(a)(1) 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." This rule applies in both structures:

• In an entity-purchase, the business pays the premiums and is the beneficiary.
• In a cross-purchase, each owner pays the premiums and is the beneficiary of the policies on the others.

Employer-owned contracts. Section 101(j) applies to an employer-owned life insurance contract: one owned by a person engaged in a trade or business that is directly or indirectly a beneficiary under it and that covers the life of an insured who is an employee on the date the contract is issued. IRS Notice 2009-48, A-5, notes that "employee" includes an officer, director and highly compensated employee. For these contracts, the exclusion is capped at "the sum of the premiums and other amounts paid by the policyholder." The cap is lifted only if both of these conditions are met:

• a § 101(j)(2) exception applies, and
• written notice and consent were given before the contract was issued.

Meeting only one of these conditions does not lift the cap. The § 101(j)(2) exceptions concern the insured's status (an employee at any time during the 12-month period before death, or a director, a highly compensated employee or a highly compensated individual when the contract is issued) and amounts paid to a member of the insured's family, a designated beneficiary of the insured other than the applicable policyholder, a trust for either, or the insured's estate, or used to purchase an equity (or capital or profits) interest in the applicable policyholder from one of those persons. Under § 101(j)(4), notice and consent are met if, before the contract is issued, the employee is notified in writing that the applicable policyholder intends to insure the employee's life and of the maximum face amount, provides written consent to being insured and to coverage that may continue after employment ends, and is informed in writing that an applicable policyholder will be a beneficiary of the proceeds.

Notice 2009-48, A-1, says 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 contract. However, A-3 says that, for a contract otherwise described in § 101(j)(3), ownership "by a partnership or sole proprietorship does not prevent the contract from being treated as" one.

Transfer for value. Under § 101(a)(2), when a policy is transferred for valuable consideration, the exclusion is limited to two amounts added together:

• the actual value of the consideration, and
• the premiums and other amounts the transferee pays afterward.

The limit does not apply to a transfer if the contract's basis in the transferee's hands is determined in whole or in part by reference to its basis in the transferor's hands (§ 101(a)(2)(A)). Section 101(a)(2)(B) also excepts certain transfers from this limit:

• a transfer "to the insured,"
• a transfer "to a partner of the insured,"
• a transfer "to a partnership in which the insured is a partner," and
• a transfer "to a corporation in which the insured is a shareholder or officer."

A fellow shareholder of a corporation does not appear on that list.

Who Owns the Policy and Who Pays the Premiums

In a direct cross-purchase, each individual owner is the policy owner, the premium payer and the beneficiary of the policies on the other owners. The owner pays the premiums from personal funds, which may include compensation the business paid to that owner.

In an entity-purchase, the business is the owner, the payer and the beneficiary. The premiums are a business outlay. Because the business is a beneficiary, § 264(a)(1) allows no deduction for them.

Owners may also choose a trusteed cross-purchase, in which a trustee holds the policies under a trust document. Its legal and tax effects depend on how that document is drafted.

The entity form also affects results. Each entity form's page addresses its own questions.

Insurers differ in their premiums, policy types and procedures, so these are confirmed with the insurers involved.

Coverage and Funding Considerations for a Multi-Owner Buy-Sell

Coverage may be tied to each owner's share of the agreed business value. Because business value can change over time, owners may revisit the agreement and the coverage amounts.

A price below fair market value may be disregarded for estate tax unless all three tests in § 2703(b) are met.

Life insurance death proceeds fund the death trigger. A death benefit does not fund disability or retirement triggers, so owners may choose other funding for those events, such as installment notes or a sinking fund.

The page on how much buy-sell coverage explains how coverage is commonly sized. The site's calculator produces an educational illustration only.