How a Cross-Purchase Agreement Works
In a cross-purchase agreement, the owners — not the company — are the parties to the buy-sell contract. Each owner buys a life insurance policy on every other owner and names themselves as the beneficiary. When an owner dies, the surviving owners receive the insurance proceeds directly, then use those proceeds to buy the deceased owner’s membership interest from the estate.
The surviving owners’ basis in the purchased shares is the price they paid. If the business later sells, each owner’s capital gain is calculated from that stepped-up basis — not from their original investment. Cross-purchase agreements give surviving owners a step-up in basis equal to what they paid for the shares at the triggering event.
The trade-off is policy count. A two-owner business requires two policies. A three-owner business requires six (each owner covers the other two). A four-owner business requires twelve. For businesses with more than three owners, the administrative burden of cross-purchase agreements often makes a different structure more practical.
How an Entity Redemption Agreement Works
In an entity redemption agreement, the company is the contracting party. The company buys life insurance on each owner, names itself as beneficiary, and at a triggering event uses the proceeds to redeem the deceased owner’s shares. The remaining owners’ percentage ownership increases automatically — they do not personally receive or spend any money.
Entity redemption is administratively simpler for multi-owner businesses: one policy per owner, owned by the company. Premiums are paid from company funds. The company manages all the policies centrally.
The trade-off is basis. When the company redeems shares, the surviving owners do not purchase anything — their percentage increases because the pool of shares shrinks. Surviving owners get no step-up in basis. Their original basis remains unchanged, which means a larger capital gain when the business eventually sells.
What the Connelly Ruling Changed for Entity Redemption
Before June 6, 2024, practitioners debated whether life insurance proceeds held by a company to fund a redemption increased the company’s value for estate tax purposes. The argument against inclusion: the proceeds were offset by the redemption obligation — the company’s contractual duty to spend those proceeds buying back the deceased owner’s shares.
In Connelly v. United States (2024), the Supreme Court rejected that argument unanimously. The Court held:
Life insurance proceeds received by the corporation are included in the company’s fair market value. The redemption obligation — the promise to spend those proceeds — does not reduce the value because it is not a debt to a third party.
The practical effect: when a company receives $3 million in insurance proceeds at an owner’s death, that $3 million is added to the company’s FMV for estate tax purposes. The deceased owner’s estate is taxed on a company value that includes those proceeds. The surviving owners then use the same $3 million to execute the redemption — but the estate has already been taxed as if those funds were part of the company’s net worth.
In the actual Connelly case, the estate owed $889,914 in additional estate tax because the company’s insurance proceeds were included in FMV. The redemption was structured exactly the way it was intended — the problem was that the structure itself produced the tax exposure.
Cross-purchase agreements are not affected by Connelly. Because the insurance proceeds flow to the surviving owners directly — not to the company — they are never part of the company’s FMV. Cross-purchase agreements avoid the Connelly estate tax problem entirely.
For a full breakdown of how funding structure interacts with Connelly, see Funded vs. Unfunded Buy-Sell Agreements in Georgia.
S-Corp Considerations for Each Structure
Georgia S-Corporations have shareholder eligibility rules that interact differently with each structure.
In a cross-purchase agreement, the surviving owners personally receive the insurance proceeds and personally buy the deceased owner’s shares. The transfer is owner-to-estate, then estate-to-surviving-owner. As long as the surviving owners are eligible S-Corp shareholders, the S election is unaffected.
In an entity redemption agreement, the company redeems shares back into treasury. The shares are effectively canceled. No new shareholder is introduced, and no ineligible entity acquires stock. An entity redemption does not risk the S election if executed correctly.
The risk arises if the deceased owner’s estate or trust is an ineligible S-Corp shareholder and holds the shares too long before the redemption closes. Under IRC § 1362(d)(2), the S election terminates on the first day an ineligible shareholder holds stock. The buy-sell agreement must include a short closing window — typically 30 to 90 days — and specify which trust types are permitted to hold shares temporarily during that window. Most templates do not include this language. For a full comparison of LLC and S-Corp shareholder eligibility rules and how they affect estate planning, see LLC vs. S-Corp for Estate Planning Purposes in Georgia.
The Insurance LLC — An Alternative for Three or More Owners
For businesses with three or more owners who want cross-purchase economics without managing N×(N-1) policies, a partnership or LLC can serve as the insurance vehicle.
Each owner contributes premium payments to a separate LLC. The LLC owns one policy per owner and distributes proceeds to the surviving owners at death. Each owner then uses their distribution to buy the deceased owner’s shares directly — preserving the step-up in basis that cross-purchase provides, while centralizing the policy management that entity redemption simplifies.
The insurance LLC structure requires careful drafting and ongoing administration. It is not appropriate for every business, but for companies with three to six owners it often produces better economics than either pure structure alone.
Which Structure Fits Your Business
The right structure depends on four variables: number of owners, current valuation, whether the business is an S-Corp, and whether estate tax exposure is a concern.
Two owners, S-Corp, estate tax exposure likely: cross-purchase. Two policies, basis step-up, no Connelly exposure. The administrative burden of two policies is low.
Two owners, LLC, no estate tax concern: entity redemption is simpler and the Connelly issue may not be material if the estate is below the federal exemption ($13.61 million in 2024, indexed for inflation). Still worth reviewing post-Connelly.
Three or more owners: evaluate the insurance LLC structure or entity redemption with explicit Connelly protections. Pure cross-purchase requires (N×(N-1)) policies and becomes administratively difficult above three owners.
Any existing entity redemption agreement drafted before June 2024: review it with an attorney. The Connelly ruling applies to all entity redemption structures — not just new ones.
At The Hive Law, a buy-sell agreement review and redraft costs $1,500 to $3,000 as a flat fee. See the buy-sell agreement pricing page for a full breakdown. For the complete succession planning picture, see the business succession planning service page.
