Your buy-sell agreement is a promise to write a check. Where’s the check?
Most partnerships have the document — a buy-sell agreement that says when one owner dies, the survivors buy the shares at a set price. Far fewer have the funding. An unfunded buy-sell is a legal obligation to produce hundreds of thousands or millions of dollars, due on the death of the person whose absence just cut the company’s earnings — payable to a grieving spouse who is now, legally, your business partner.
Life insurance is a common way to fund a buy-sell: the policies are sized to the agreement’s purchase obligation, and the death benefit can be income-tax-free when the ownership and employer-owned contract rules are met. The design question — who owns the policies — got a lot more expensive to get wrong in 2024.
Connelly changed the math
In Connelly v. United States (2024), the Supreme Court held that insurance proceeds a company receives to redeem a deceased owner’s shares INCREASE the company’s value for estate tax — the deceased’s estate gets taxed on insurance meant to buy them out. Entity-redemption structures written before 2024 need a re-read. The Court noted that a cross-purchase agreement would have avoided that increase, but said it has drawbacks of its own: each owner must keep paying premiums on the others, and it carries its own tax consequences.
Cross-purchase vs entity redemption
Cross-purchase: partners own policies on each other; the proceeds go to the survivors rather than the company, and each survivor’s basis in the shares they buy is the price paid. Redemption: the company owns one policy per partner — simpler with many partners, but post-Connelly it can inflate the taxable estate. Some multi-partner firms use a trusteed cross-purchase or an insurance LLC instead; how either is taxed depends on how it is set up, so it needs review by your attorney and CPA.
The valuation goes stale faster than the document
A buy-sell priced at the 2019 valuation funds a 2019 buyout. If the company doubled, the coverage buys half the shares and the balance comes from cash flow — at the worst possible time. We review the funding against current valuation on a schedule, not once a decade.
Company-owned policies and §101(j)
In an entity redemption the company owns the policies and is their beneficiary. If an insured owner is an employee of the company when a policy is issued — for this rule, employees include officers and directors — the policy is an employer-owned contract under IRC §101(j). Whether a particular owner counts depends on the entity and the owner’s role, so confirm it with your CPA. Under current federal tax law, the death benefit above premiums paid is then taxable unless, before the policy was issued, the insured received written notice (including the maximum face amount) and consented in writing, and an exception applies — for example, to the extent the proceeds are used to buy the deceased owner’s interest from the owner’s family members, an individual other than the company named as the owner’s beneficiary, a trust for any of them, or the owner’s estate. Adding coverage later can require a new notice and consent (IRS Notice 2009-48), and the company files Form 8925 each year.