Entity vs. Cross-Purchase Buy-Sell Agreements: Which Is Right for You Post-Connelly?
For years, business owners have been told that having a buy-sell agreement in place is the gold standard for making sure their company doesn’t implode when a partner dies. It’s supposed to provide certainty, continuity, and liquidity. But here’s the problem: a buy-sell agreement is only as good as its structure. And thanks to the Connelly v. United States (2024) ruling, the way you fund that agreement could mean the difference between a clean transfer and a nasty estate tax bill that blindsides your heirs.
This is where the big question comes in: entity-purchase or cross-purchase? One makes the IRS very happy. The other might just set your heirs up for financial disaster. Let’s break it down.
Entity-Purchase Agreements: The IRS’s New Favorite Target
Entity-purchase (or stock redemption) agreements are the simpler of the two. The company itself owns life insurance on each owner, and when one dies, the business collects the insurance payout and uses that money to redeem the deceased owner’s shares. Sounds clean, right? Well, thanks to Connelly, not anymore.
Here’s the issue: the IRS now says those life insurance proceeds are a corporate asset when determining the company’s value for estate tax purposes. That means if your company gets a $5 million payout to redeem your shares, the IRS isn’t ignoring it—they’re counting it as part of the business’s fair market value. And guess what? That just jacked up your estate’s tax bill.
Even worse, the estate only gets the agreed-upon buyout price, but the IRS is taxing it on a much higher valuation—one that includes the very money that was supposed to fund the buyout. That means your heirs could be left scrambling to pay estate taxes on phantom value they never actually receive.
And don’t even get me started on basis. Surviving owners don’t get a step-up in basis on the shares they retain, which means a higher capital gains tax bill if they ever sell the business down the road. It’s a lose-lose situation.
Cross-Purchase Agreements: The Tax-Efficient Alternative
Now, let’s talk about the cross-purchase agreement—the structure that Connelly indirectly blessed as the smarter way to go. Instead of the business owning life insurance, each owner personally owns a policy on the other owners. When one dies, the surviving owners get the payout directly and use that money to buy the deceased owner’s shares from the estate.
Why is this better? Simple:
The insurance money never touches the company. That means the IRS can’t inflate the business’s value for estate tax purposes by counting the payout as a corporate asset.
Your heirs only get taxed on what they actually receive. No nasty surprises. No estate tax bill on money they never see.
Surviving owners get a step-up in basis. If they ever sell the company down the road, their taxable gain is much lower because their basis in the purchased shares is now the buyout price.
The biggest downside to a cross-purchase plan? Complexity. If there are multiple owners, each has to own policies on every other owner, which can lead to a logistical headache. But there are solutions, like life insurance LLCs, that simplify the process and still keep the tax benefits intact.
Which One Is Right for You?
If your buy-sell agreement is currently structured as an entity-purchase agreement, it’s time to rethink it. The IRS is going to scrutinize these agreements more aggressively, and the tax consequences could be devastating. A cross-purchase plan is almost always the safer bet now, especially if your goal is to minimize estate tax exposure and maximize tax efficiency for the surviving owners.
What You Should Do Right Now
Review your buy-sell agreement immediately. If it’s an entity-purchase plan, it’s time to explore alternatives.
Talk to your advisors. Your estate planning attorney, CPA, and financial professional need to be on the same page about how Connelly impacts your business.
Consider switching to a cross-purchase agreement. If logistics are an issue, look into using a life insurance LLC to manage policy ownership efficiently.
Act now. The federal estate tax exemption is dropping in 2026. What seems like a “future problem” could hit much sooner than you think.
Final Thoughts
The Connelly ruling exposed a major flaw in traditional entity-purchase buy-sell agreements, and business owners who don’t adapt could leave their heirs with a massive tax burden. Cross-purchase agreements aren’t just a workaround—they’re a smarter, more tax-efficient way to ensure business continuity without handing the IRS a bigger cut than necessary.
If your succession plan isn’t optimized for this new reality, now is the time to fix it. Because when it comes to estate taxes, ignorance isn’t just expensive—it’s catastrophic.
