A cross-purchase buy-sell agreement is a contract in which the owners of a business agree to buy a departing owner’s share themselves, usually with life insurance each owner holds on the others. It works especially well for companies with two or three owners. The trade-off is administration, because every owner you add multiplies the number of policies.
If you are still sorting out the basics, start with our guide, What Is a Buy-Sell Agreement. This article goes deeper on the cross-purchase structure: how it works, what it costs to run, where the tax traps sit, and what Arizona owners should check.
What Is a Cross-Purchase Agreement
It is a contract among the owners themselves, with the company standing to the side. When a triggering event happens, such as a death, the departing owner’s estate sells the ownership interest directly to the other owners rather than back to the company.
Life insurance usually carries the death side of the deal:
- Each owner applies for, owns, and pays for a policy on each of the other owners.
- Each owner names himself or herself as the beneficiary of the policies he or she owns.
- When an owner dies, the survivors receive the death benefit, which is generally free of income tax.
- The agreement requires the survivors to use that money to buy the deceased owner’s share from the estate.
The estate ends up with cash, and the surviving owners end up with the company. That handoff sits at the heart of business succession planning, because it decides who controls the company and how the family of the owner who died gets paid.
How Many Life Insurance Policies Does a Cross-Purchase Agreement Need
Multiply the number of owners by one less than that number. Each owner insures every other owner, so the count grows fast:
- 2 owners need 2 policies
- 3 owners need 6 policies
- 4 owners need 12 policies
- 5 owners need 20 policies
- 6 owners need 30 policies
Cost adds a second wrinkle. A policy on an older or less healthy owner costs more, so the younger owner often pays the larger premium to insure the older partner. Owners should decide up front whether they want to even that out and how.
For two owners, the classic cross-purchase setup stays simple. Past that point, many companies look at a trusteed arrangement or a separate insurance LLC, both covered below.
Cross-Purchase Buy-Sell Agreement vs Entity Purchase
The difference comes down to who buys. In an entity purchase, also called a redemption, the company owns one policy on each owner and buys back the departing owner’s share itself.
Entity plans are easier to administer, and that simplicity has costs of its own:
- Cost basis. Survivors in a cross-purchase add what they pay to their basis. In an entity purchase, the surviving owners’ basis generally does not rise by the purchase price.
- Company value. Policies inside the company add to the company’s assets, and death benefits can raise the company’s value for estate tax purposes.
- Paperwork on company-owned policies. A company that owns insurance on its employees has to meet federal notice and consent rules and file Form 8925 to keep the death benefit tax-free.
How the Basis Difference Plays Out
Take a company worth $2 million, owned 50/50 by two owners who each have a $100,000 basis.
- Cross-purchase. One owner dies. The survivor uses $1 million of insurance to buy the other half. The survivor’s basis becomes $1.1 million: $100,000 on the original half plus $1 million on the purchased half.
- Entity purchase. The company collects the $1 million and buys the shares. The survivor still owns 100% of the company, but the basis stays at $100,000, apart from a partial increase S corporation rules can allow for the insurance proceeds.
Now suppose the survivor later sells the company for $2 million. Before any S corporation adjustment, the cross-purchase leaves $900,000 of taxable gain. The entity purchase leaves $1.9 million. That $1 million gap in gain is often the strongest argument for the cross-purchase structure.
Why the Connelly Decision Shifted Attention
In 2024, the Supreme Court ruled in Connelly v. United States that life insurance a corporation holds to redeem a deceased owner’s shares can raise the company’s value for estate tax. A cross-purchase keeps the policies outside the company, so the death benefit never lands on the company’s books. Our buy-sell guide linked above walks through the case in detail.
An entity plan can still make sense for a company with many owners, or for owners whose estates sit well below the federal estate tax threshold. Even then, the basis difference applies, so the choice deserves a real comparison rather than a default.
What Happens to the Other Policies When an Owner Dies
The deceased owner’s estate still owns the policies he or she held on the surviving owners, and those contracts need a new home. Permanent policies may carry cash value, so the agreement should say who buys them and at what price.
The cleanest path usually has each surviving owner buy the policy on his or her own life. Federal tax law exempts a sale to the insured person from the transfer-for-value rule, which can otherwise make part of a future death benefit taxable when someone buys an existing policy.
The same rule deserves attention any time policies change hands: when you add an owner, when one retires, or when you switch from an entity plan to a cross-purchase. The exceptions cover 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. A transfer between two shareholders of the same corporation does not appear on that list. A Southern Arizona Estate Planning Council presentation on buy-sell planning lays out the rule and its exceptions for local advisors.
What Are the Disadvantages of a Cross-Purchase Buy-Sell Agreement
The main drawbacks are the policy count, uneven premiums, and the need for every owner to keep paying on time.
- Too many policies. Four owners already means twelve contracts to track, fund, and update.
- Uneven costs. Age and health differences make some policies far more expensive than others.
- Personal premiums. Owners pay the premiums themselves. If the company pays instead, the payment counts as taxable compensation or a distribution to the owner.
- No deduction. Premiums on policies that fund a buy-sell are not tax-deductible.
- Lapse risk. If one owner stops paying, the agreement quietly loses its funding.
- Death-only funding. Life insurance pays only at death. Disability and retirement buyouts need their own plan, such as disability buyout coverage or payments spread over several years.
- Harder to unwind. Selling the company or changing owners means reshuffling policies, with the transfer-for-value rule in play.
Can an LLC Have a Buy-Sell Agreement
Yes. Many LLCs write the buyout terms directly into the operating agreement, and LLCs taxed as partnerships hold a real advantage for cross-purchase plans.
Members of an LLC taxed as a partnership count as partners for this purpose. Policies can move between them under the partner exception to the transfer-for-value rule, which makes changes in ownership easier to handle.
Owners of corporations sometimes borrow that advantage by forming a separate LLC whose only job is to hold the buy-sell policies. The insurance LLC owns one policy on each owner, collects the death benefit, and passes it to the surviving members, who then buy the deceased owner’s shares in the operating company. The structure pairs the one-policy-per-owner simplicity of an entity plan with the basis result of a cross-purchase. The cost is a second agreement to maintain and, in some cases, a partnership tax return.
What Arizona Owners Should Check
Arizona adds two considerations most national guides skip.
Community property. Arizona is a community property state, so a married owner’s spouse may hold a community interest in the shares. The agreement should address that interest directly, and your attorney may ask each spouse to sign it.
The state tax on a later sale. Arizona taxes capital gains at its flat 2.5% rate and lets you subtract 25% of a long-term gain only on assets acquired after December 31, 2011. Shares a survivor buys through the agreement carry the purchase date as their acquisition date. An owner who founded the company in the 1990s may hold original shares that miss the subtraction and purchased shares that qualify for it. Our guide to the tax implications of selling a business in Arizona covers the state and federal pieces together.
Frequently Asked Questions
What Are the Four Types of Buy-Sell Agreements
Most planners group them as cross-purchase, entity purchase (also called stock redemption), wait-and-see, and trusteed cross-purchase. A wait-and-see plan leaves the choice of buyer open until the triggering event. A trusteed plan has a trustee hold one policy on each owner for the group. Insurance LLCs have become a fifth option for companies with several owners.
What Is the 3-Year Rule for Life Insurance
If you give away a policy on your own life and die within three years, federal law still counts the death benefit in your estate. In a cross-purchase plan, owners hold policies on each other rather than on themselves, so the rule mostly comes into play when an owner transfers an existing policy on his or her own life.
How Much Coverage Does Each Owner Need
Enough to buy the share you would have to purchase. Two equal owners of a $2 million company would each carry $1 million on the other. As the company’s value changes, the coverage and the price formula in the agreement should move together.
Is the Death Benefit Taxable to the Surviving Owners
Generally no. Life insurance payouts are usually free of income tax, unless a prior sale of the policy triggers the transfer-for-value rule.
How We Coordinate Buy-Sell Funding at Global Investment Strategies
We have worked with Tucson business owners since 2009. Your attorney drafts the buy-sell agreement, and your CPA handles the basis and tax reporting. Our role is making sure the funding matches the promise.
That means sizing coverage to the company’s current value, comparing policies across carriers as part of our life insurance planning, tracking who owns and pays for each contract, and lining the agreement up with each owner’s estate plan. When ownership changes, we help plan the policy moves before anyone signs a transfer.
Check Whether Your Buy-Sell Agreement Still Matches Your Company
Owners usually sign these agreements once and rarely reopen them. The company’s value, the owners’ health, and the tax rules all move in the meantime.
We work with business owners across Tucson, Oro Valley, Marana, and the Catalina Foothills. Request a private conversation and we will compare your agreement, your coverage, and your valuation alongside your attorney and CPA.
Global Investment Strategies provides educational planning concepts and works alongside your qualified legal, tax, and financial professionals. This article is educational and is not individualized tax, legal, or financial advice. Tax rules described here reflect federal and Arizona law as of September 2026 and change over time. Review any buy-sell structure with your attorney and CPA before acting.
