A buy-sell agreement and life insurance let 2 or 3 co-owners fund a buyout at death, and Corient Wealth Management compares structures by the tax basis each one leaves the surviving owner. Many owners assume the insurance makes the whole buyout tax-free. The death benefit usually is tax-free, but premiums are paid with after-tax money, and in a C corporation only a cross-purchase gives the survivors new basis equal to the price they pay.
The question we hear most in first meetings goes something like this: "We bought a policy on each other years ago, so are we covered?" Maybe. Covered for cash, yes, if the policy is still in force. Covered for tax, price and fairness to the families is a separate matter, and that is what the sections below take apart, using a hypothetical printing company with three partners.
By Marcus Thompson, CFA — Wealth Manager | Reviewed by Sarah Chen, CFPMarcus builds diversified portfolios for high-net-worth clients, with deep expertise in asset allocation and risk management.
In a C corporation, a redemption adds no basis for the survivors. A cross-purchase turns a $2,000,000 price into $2,000,000 of basis, and that difference shows up at the exit.
CPA and Tax Director, Corient Wealth Management
If one owner would have to insure a stake 3 times his own, the cross-purchase usually stops being affordable. That's when we look at an entity plan.
CFP® and Lead Advisor, Corient Wealth Management
The insurance money makes the whole buyout tax-free
Owners say it like this: "The policy pays, the estate gets paid, and nobody owes anything." The rule is narrower. Section 101(a) of the Internal Revenue Code generally keeps a life insurance death benefit out of the beneficiary's income, and that is the only tax-free part. The deceased owner's heirs also usually get a basis step-up at death, so the sale itself often produces little gain on their side.
Premiums are another story. Under section 264 they are not deductible when the payer is also the beneficiary. In a partnership, the premium is a nondeductible expense that passes through to the partners and lowers their outside basis. The cost isn't saved, it's paid with after-tax money, years before the payout.
Then there is the transfer-for-value rule. If a policy is sold or transferred for value, the proceeds can become taxable. The exceptions cover the insured, a partner of the insured, a partnership in which the insured is a partner, and a corporation in which the insured is a shareholder or officer. A transfer to a co-shareholder is not covered, so C corporation owners who swap company-owned policies with each other can turn tax-free proceeds into income.
Check every past policy transfer before an owner dies. A transfer for value between co-shareholders of a C corporation can make the death benefit taxable.
Cross-purchase or company-owned: the survivor's basis is not the same
Owners often believe both structures leave the survivor in the same place. In a C corporation they don't. A redemption raises the survivors' ownership percentage but adds nothing to their share basis. In a cross-purchase, the price each survivor pays becomes basis. In the example below, that is $2,000,000 of basis, which shrinks the gain on the later exit. Rows 2 and 3 of the table are the basis rows.
Hypothetical $8,000,000 company, Luis's 25% valued at $2,000,000, and the IRS and court rules each row cites.
Partnerships are different. Tax-exempt insurance proceeds received by the partnership increase the partners' outside basis under section 705. How much of that reaches the survivors depends on how the partnership agreement allocates the proceeds and on whether a section 754 election is in place, so the gap can be much smaller than in a C corporation. Before you pick a structure, get your CPA to run the cross-purchase and the entity plan side by side, using your own allocation language.
Policy count and affordability are the trade-off. A cross-purchase among 3 unrelated owners needs 6 policies, because each owner insures the other 2. An entity plan needs 3. When stakes are lopsided, the small owner can't carry the premium: Luis would have to insure the couple's $6,000,000 stake, 3 times his own $2,000,000.
Owners with similar stakes who can pay premiums personally and expect to sell within about 10 years gain the most from a cross-purchase. Lopsided ownership usually points to an entity plan or a wait-and-see agreement, where the company has the first option to buy and the owners buy whatever it does not. Our decision rule: in a C corporation whose survivors expect to sell within about 10 years, favor a cross-purchase. If one owner would have to insure a stake 3 or more times his own, use an entity or wait-and-see structure.
Why the C corporation basis gap exists
Six policies or three
| Common belief | What the rule says | What it means for you |
|---|---|---|
| Insurance makes the buyout tax-free | Death benefit excluded; premiums not deductible | Premiums come from after-tax money |
| Both structures give the same basis | C corp redemption adds no survivor basis | Cross-purchase: basis equals $2,000,000 paid |
| Partnerships work like corporations here | Exempt proceeds raise partners' outside basis | Check how proceeds are allocated |
| Our agreed price binds the IRS | Section 2703: bona fide, arm's-length terms | Update and document the price formula |
| Company-owned policy adds no value | Connelly: proceeds count, no redemption offset | Matters near $15,000,000 exclusion |
| Policies move between owners freely | Co-shareholder transfer can tax proceeds | Partners have an exception |
The price in our agreement is the price the IRS will accept
Not automatically. Under section 2703, an agreement price is disregarded for estate tax unless it is a bona fide business arrangement, is not a device to pass value to family, and is comparable to arm's-length terms. Under Connelly v. United States, proceeds of a company-owned policy count in the corporation's value, and the redemption obligation does not offset them. For an estate under the $15,000,000 per-person exclusion for 2026 this rarely creates estate tax. For larger estates it can, and a cross-purchase keeps the proceeds out of the company's value.
Luis is 58: insuring the buyout now, at 60 or at 63
A hypothetical household: Minh, 54, and Joanne, 52, hold 75% of an $8,000,000 printing company taxed as a partnership, and a third partner, Luis, age 58, holds 25%, so his share is worth $2,000,000. They plan to exit in 5 to 7 years. If Luis died uninsured, the couple would buy his interest personally with after-tax money. At an assumed 37.5% combined rate, for illustration, $2,000,000 ÷ 0.625 = $3,200,000 of pretax profit. That is about 4.6 years of a $700,000 year, or nearly 13 years of a $250,000 year. You can enter your own stake, tax rate and profit into the calculator on this site to see your version of that gap.
Timing changes the exposure. Coverage bought now protects all 5 to 7 years before the exit, and a 10-year term policy runs past it. Waiting until Luis is 60 leaves 2 uncovered years; waiting until 63 leaves 5. Each later underwriting prices an older insured whose health may have changed, and insurability lost to a diagnosis cannot be bought back.
Putting off the policies until the exit is in sight leaves the riskiest years unfunded. A death in those years would force the survivors to earn about $3,200,000 of pretax profit to pay Luis's family $2,000,000, and an older or less healthy owner may no longer qualify at all.
What did they choose? The couple owns a $2,000,000 policy on Luis, which gives them $2,000,000 of basis if it pays. Their agreement lets a deceased spouse's interest pass to the other spouse, and a partnership-owned survivorship (second-to-die) policy funds a buyout only if both die, so Luis does not have to insure $6,000,000.
One caveat. Life insurance only funds the death trigger. Disability and retirement buyouts need disability buyout coverage, a note or a sinking fund. For owners closing a sale within about 2 years, or a company holding enough spare cash to pay the price, new premiums may not be worth it.
The unfunded cost
What waiting costs
What happens if Luis dies and his family inherits 25% of a printing company?
If the buyout is funded, Luis's widow receives $2,000,000 in cash for an interest whose basis stepped up at death, so she owes little or no capital gains tax, and she isn't left holding a minority stake with no say in the exit.
For Minh and Joanne, the agreement must name the surviving spouse as a permitted transferee. Without that clause, the death of one spouse could trigger a forced sale of a 37.5% interest to Luis, which is the opposite of what their heirs would want.
When can you still change the agreement, and what is locked once an owner dies?
The agreement can be amended any time all owners sign. Among partners, policy ownership can move within the transfer-for-value exceptions. Insurability can't be reversed, and once an owner dies, the agreement in force that day governs the price and terms.
The deadlines run in this order. Now: medical underwriting takes several weeks. Each year: the valuation or price update the agreement requires. Once a buyer shows serious interest, and well ahead of signing a letter of intent: check whether the agreement ends at a sale and what happens to the policies. At a death: the purchase window the agreement sets. Form 706 is generally due 9 months after the date of death, with a 6-month extension available from the IRS.
Gather the paperwork before the review: the signed buy-sell and partnership agreement (attorney's file), in-force policy ledgers and beneficiary designations (insurer or agent), each owner's Schedule K-1 and outside-basis records (CPA), and the latest business valuation (appraiser). Then put these to your CPA and attorney:
Reversible and locked
Deadlines and paperwork
- How proceeds are allocated
- Whether a section 754 election exists
- Owner and beneficiary on each policy
- Any past transfers for value
- Whether the price clause meets section 2703
- What happens to policies at the exit
The question for Corient Wealth Management about your buy-sell funding
Ask Corient Wealth Management to set the basis each structure would leave the survivors next to the after-tax premium each owner pays until the planned exit. If the agreement and the policies point to different structures, that mismatch is what to fix first. Related topics, such as family business succession and business exit planning, build on the same numbers.
The death benefit is tax-free, but the premiums are paid with after-tax money, years before the payout.
Questions about buy-sell agreement and life insurance
Is buy-sell life insurance worth paying for if we plan to sell the company within 5 years?
Does term or permanent life insurance work better for funding a cross-purchase agreement?
Primary sources
This content is general information for educational purposes. It is not individualized investment, tax or legal advice for your situation. Investing involves risk, including the possible loss of principal. Before making financial decisions, consult a qualified professional who understands your circumstances.