Buy-Sell Agreement Funding
Buy-Sell Insurance for a Two-Owner Business: How the Cross-Purchase Works
Published October 9, 2026 · Updated October 9, 2026
Short Answer: Life Insurance and a Two-Owner Buy-Sell
A two-owner business can fund a buy-sell agreement with life insurance so that, if one owner dies, the surviving owner has cash to buy the deceased owner's interest from the estate. In a cross-purchase between two owners, each owner buys, owns and is beneficiary of one policy on the other owner's life, so two policies are needed.
This page is for two partners, 50/50 co-owners and their advisers looking at a two partner buy sell agreement. It covers the mechanics, policy ownership, federal tax rules and planning considerations that are specific to an arrangement with exactly two owners.
Why a Two-Owner Business Faces a Distinct Continuity Risk
With only two owners, there is no remaining ownership group to absorb a departing owner's share. When one owner dies, half or more of the business can pass to heirs who may have no role in it, leaving the survivor in forced co-ownership with an estate.
The liquidity problem runs both ways. The survivor may lack the cash to buy out the estate, and the estate may find no ready market for a minority or 50 percent interest in a closely held business.
Life insurance is one way to fund a purchase of the deceased owner's interest at the moment the agreement calls for it. With two owners, the cross-purchase is simple to describe: two owners, two policies, each insuring the other. A general overview of funding a buy-sell agreement covers non-insurance methods as well.
How Two-Owner Businesses Are Typically Structured
Legal form shapes what is being bought. A two-owner business may be a general partnership, a limited partnership, a limited liability company (LLC), an S corporation, a C corporation, or a professional entity such as a professional corporation or professional LLC. The interest sold at a death is correspondingly a partnership interest, an LLC membership interest or shares of stock, and the entity's own documents may affect its transfer.
In a 50/50 split each owner holds an equal interest, so a buy sell agreement between 50/50 owners can mirror that equality. The buy-sell agreement may be drafted to agree with the partnership agreement, operating agreement or shareholder agreement.
Professional practices may face limits on who may hold an interest; those professional-licensing and ownership rules vary by state and are not addressed here. Entity form also matters for the federal transfer-for-value exceptions, because the statute names partners and partnerships separately from corporations.
The Triggering Event: What Activates the Buy-Sell Obligation
Death is the trigger that life insurance funds. When one owner dies, the agreement's purchase terms apply, the insurer pays the death benefit to the policy's owner and beneficiary (in a cross-purchase, the surviving owner), and the survivor uses the proceeds to buy the deceased owner's interest from the estate.
Agreements may name other triggers too, such as disability, retirement, voluntary departure or divorce. A life insurance death benefit is paid on death and does not fund those events; owners may choose other funding for them, such as disability coverage or installment terms.
The price paid at the trigger comes from the agreement's valuation method, such as a fixed price, a formula or an independent appraisal. How business valuation for a buy-sell is set depends on facts specific to the business and its contracts, and it needs individual review of the contracts involved by the insurers and a qualified tax professional.
How the Cross-Purchase Works for Two Partners
Step by step, a cross-purchase buy-sell agreement between two owners runs like this:
- Owner A applies for, owns and is beneficiary of a policy on Owner B's life.
- Owner B applies for, owns and is beneficiary of a policy on Owner A's life.
- Each owner pays the premiums on the policy he or she owns.
- At one owner's death, the survivor receives the death benefit as named beneficiary.
- The survivor pays the agreed price to the estate under the terms of the agreement.
- The survivor then holds 100 percent of the business.
Because the survivor buys the interest directly, the survivor's cost basis in the purchased interest is generally the price paid, which may matter on a later sale. Section 741 of the Internal Revenue Code provides that on the sale or exchange of a partnership interest, "gain or loss shall be recognized to the transferor partner" and is generally capital, except as otherwise provided for unrealized receivables and inventory items.
In an entity-purchase buy-sell agreement, the business owns the policies and buys back the interest instead; the basis result differs, and the comparison turns on the owners' facts.
Ownership Structure and the Transfer-for-Value Rules
Ownership in a two-owner cross-purchase is crossed: each owner is owner and beneficiary of the policy on the other, and neither owns the policy on his or her own life.
Section 101(a)(1) of the Internal Revenue Code provides that, except as otherwise provided, "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." Section 101(a)(2) limits that exclusion after "a transfer for a valuable consideration" of a contract to "the sum of the actual value of such consideration and the premiums and other amounts subsequently paid by the transferee." Section 101(a)(2)(A) also excepts 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. 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, or to a corporation in which the insured is a shareholder or officer." The Treasury regulation at 26 C.F.R. § 1.101-1 illustrates these rules with examples.
A policy each owner buys new at issue has not been transferred. The rule matters when a policy moves. After a death, the deceased owner's estate holds the policy on the survivor's life. If the survivor acquires it, that is a transfer to the insured, an exception under section 101(a)(2)(B). Other post-death moves, such as a sale to a co-shareholder or to a new co-owner who is not a partner of the insured, need the transfer-for-value analysis; that question needs individual review of the contracts involved by the insurers and a qualified tax professional.
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. Under A-3, for a contract otherwise described in § 101(j)(3), ownership by a partnership "does not prevent the contract from being treated as" one, so policies held by the entity may raise section 101(j), which generally caps the exclusion at premiums and other amounts paid unless a section 101(j)(2) exception applies and written notice and consent were given before issue. The Notice is stated as of its date; whether later guidance modified it is not confirmed here.
Coverage and Funding Considerations for a Two-Owner Agreement
Sizing may start from the agreement's price: each policy's face amount may be set near the insured owner's share of the agreed business value. Business value changes, so owners may revisit both the price and the coverage; adequacy depends on facts this page does not have. A separate page on buy-sell coverage amounts covers sizing in more depth.
Both term and permanent coverage (whole life, universal life) are used. The choice affects premium cost, whether the contract carries a cash value feature, and what remains if both owners survive to retirement.
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." In a cross-purchase each owner pays premiums on a policy naming himself or herself as beneficiary, so those premiums are generally paid with after-tax dollars. Because the individual owners, not the entity, pay the premiums, the rule applies at the owner level. How it applies to a specific arrangement depends on the facts and contracts. Policy forms, charges and required provisions vary by insurer and by state.
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Who a Two-Owner Cross-Purchase Buy-Sell Is For
The typical profile is two owners, each with a material interest, whose active work is central to the business. They may be partners in a general or limited partnership, co-members of a two-member LLC, or the two shareholders of a closely held corporation.
They generally want the survivor, not the business, to acquire the deceased owner's interest directly, keeping the basis result described for a direct purchase. Each is insurable at a cost consistent with the funding need. They have agreed on a valuation method and accept that coverage is revisited as value changes. A 50/50 partnership buy sell agreement fits this profile neatly, because equal obligations are easy to mirror in two equal policies.
When a Life-Insurance-Funded Cross-Purchase May Fit
Fit tends to appear when several facts line up:
- Both owners are insurable and the premiums are manageable relative to the business's value and the owners' finances.
- The business is a partnership, so a later transfer of a policy to a partner of the insured is among the transfers section 101(a)(2)(B) excepts.
- The owners want the survivor to hold a cost basis in the purchased interest equal to the price paid, which a direct purchase generally produces.
- The owners prefer the funding obligation at the individual level, with the death benefit paid straight to the survivor rather than to the entity.
- The business value is reasonably estimable and a valuation method is agreed.
When a Life-Insurance-Funded Cross-Purchase May Not Fit
Some facts point elsewhere. One or both owners may be uninsurable, or the premiums may be out of proportion to the need.
In a two-shareholder corporation, section 101(a)(2)(B) does not list a co-shareholder of the insured (it lists a corporation in which the insured is a shareholder or officer), so later policy transfers between shareholders are analyzed differently. Owners who would rather have the entity hold the policies are looking at a redemption design instead. A highly volatile value makes coverage hard to set. Owners expecting a third owner face more policies under a cross-purchase, a situation addressed on the site's page on multiple owners.
Potential Advantages of the Two-Owner Cross-Purchase
Directness is the central feature. The survivor receives the proceeds and buys the interest, generally taking a cost basis equal to the price paid. A higher basis may reduce gain on a later sale; section 741 governs the recognition and character of gain or loss when a partnership interest is sold.
The death benefit is generally within the section 101(a)(1) exclusion, subject to the section 101(a)(2) transfer-for-value limit. For partners, section 101(a)(2)(B) excepts a transfer to a partner of the insured. Under Notice 2009-48, A-1, an owner-held policy financing the purchase of another owner's interest is not an employer-owned contract. With two owners there are only two policies and two beneficiary designations.
Important Considerations and Planning Risks
The agreement itself governs the purchase terms, and a poorly drafted agreement may not produce the intended purchase. Underfunding is one gap that can arise: if value outgrows coverage, the survivor is short of the price.
Premium risk sits with each owner. In Connelly v. United States, the Supreme Court observed 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." If an owner becomes uninsurable, other funding is needed for that share.
For estate tax, section 2703(a) determines value without regard to a right to buy property below fair market value or a restriction on the right to sell or use it, unless under section 2703(b) the agreement "is a bona fide business arrangement," "is not a device to transfer such property to members of the decedent's family for less than full and adequate consideration," and has terms "comparable to similar arrangements entered into by persons in an arms' length transaction." That question, along with corporate-form transfers and any post-death policy move other than to the insured, depends on the facts and contracts. The agreement may also say what happens to the policies if the business dissolves or an owner retires.
Alternatives to a Life-Insurance-Funded Cross-Purchase
Other funding paths exist, each with its own cost:
- Entity purchase (redemption): the business owns the policies and buys back the interest.
- Installment purchase: the survivor pays the estate over time from earnings, with cash-flow risk if earnings fall short.
- Sinking fund: reserves built up for the buyout, which takes time and discipline.
- Third-party financing: the survivor borrows, taking on debt service.
- Hybrid: insurance for most of the price, installments for any shortfall.
Businesses with more than two owners face more policies under a cross-purchase and may consider other designs, such as an entity purchase. Later policy changes, such as an exchange or a term conversion, may affect the buy-sell structure and are outside this page.
Planning Example: A Hypothetical 50/50 Two-Owner Partnership
This example is hypothetical. Assumptions: two equal partners in a partnership, A and B; agreed business value $2,000,000; both insurable; no transfers of either policy; premiums and other costs ignored.
- Each interest: $2,000,000 × 50% = $1,000,000.
- Policies: A owns a $1,000,000 policy on B's life; B owns a $1,000,000 policy on A's life.
- Trigger: A dies. B, as owner and beneficiary of the policy on A's life, receives $1,000,000.
- Purchase: B pays $1,000,000 to A's estate; the estate transfers A's 50% interest. B now owns 50% + 50% = 100%.
- Basis: B's cost basis in the purchased half is generally $1,000,000, the price paid.
Under section 101(a)(1), the death benefit is generally excluded from B's gross income, subject to the transfer-for-value rules and the other limits in section 101; if the policy had been transferred to B, section 101(a)(2)(B) would except it because B is a partner of the insured. A's estate then holds the policy on B's life, and B acquiring it would be a transfer to the insured. The example shows no reader's actual result.
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Frequently Asked Questions
How many life insurance policies are needed for a two-owner cross-purchase buy-sell agreement?
Two. Each owner buys and owns one policy on the other's life: Owner A owns the policy on Owner B, and Owner B owns the policy on Owner A. Each owner is also the beneficiary of the policy he or she owns.
Is the death benefit received by the surviving partner taxable income?
Section 101(a)(1) generally excludes death proceeds from gross income, subject to the section 101(a)(2) transfer-for-value limit. Section 101(a)(2)(B) excepts a transfer to a partner of the insured. Whether the exclusion holds for a particular arrangement depends on its facts and contracts.
What happens to the life insurance policies after one partner dies and the buyout is complete?
The deceased owner's estate holds the policy on the survivor's life. If the survivor acquires it, that is a transfer to the insured, an exception under section 101(a)(2)(B). Any other post-death move of that policy needs a transfer-for-value analysis.
How is the business valued for a two-owner buy-sell agreement?
Agreements may use a fixed price, a formula or an independent appraisal at the trigger. For estate tax, section 2703(b) sets the conditions under which the agreement's price is not disregarded. Valuation turns on facts specific to the business.
What is the transfer-for-value rule and how does it affect a two-partner cross-purchase?
Section 101(a)(2) limits the death-benefit exclusion after a policy is transferred for valuable consideration, to the consideration plus later premiums and other amounts. Section 101(a)(2)(B) excepts transfers 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.
What happens if one partner becomes uninsurable after the buy-sell agreement is in place?
Insurance funding for that owner's share may then be unavailable. Owners may address this with alternative funding, such as installment payments or a sinking fund, for the uncovered share.
Educational information only. Not legal, tax, investment or insurance advice. Product availability and outcomes depend on individual circumstances.