Entity Purchase vs. Cross-Purchase: Choosing How to Fund a Buy-Sell Agreement

The two most common buy-sell structures handle ownership, cost basis, and estate valuation differently. Here are the questions business owners should raise with their attorney and CPA before insurance is placed.

Every buy-sell agreement has to answer a basic question: who buys a departing owner's interest? In an entity-purchase (redemption) agreement, the business buys it. In a cross-purchase agreement, the remaining owners buy it personally. Insurance funding follows that choice, so the structure should be settled first.

Entity purchase is simpler to administer: the business owns one policy per owner and pays the premiums. The tradeoffs are that surviving owners generally do not receive an increase in their cost basis, and in Connelly v. United States (2024) the U.S. Supreme Court held that corporate-owned life insurance proceeds used for a redemption are counted when valuing the corporation for federal estate tax purposes, without an offsetting reduction for the redemption obligation.

Cross-purchase keeps the proceeds outside the business and generally gives surviving owners a cost basis equal to what they paid. Its main drawback is the number of policies: each owner needs coverage on every other owner. Trusteed cross-purchase arrangements or a separate LLC that owns the policies can reduce the count, but they bring their own legal and tax review requirements, including the transfer-for-value rule.

Valuation deserves equal attention. Agreements that rely on a fixed price should require periodic updates, and coverage amounts should be reviewed at the same time. Agreements should also address disability, retirement, and voluntary departure, which life insurance alone does not fund.

For entity-owned policies, Internal Revenue Code Section 101(j) notice-and-consent requirements must be satisfied before the policy is issued. Premiums for buy-sell coverage are generally not deductible.

This article is educational and is not legal or tax advice. The right structure depends on your entity type, number of owners, state law, and estate plan, and should be decided with your attorney and CPA.