An entity purchase agreement is a buy-sell arrangement in which the business itself — not the other owners individually — agrees to buy a departing owner’s interest when they die, retire, become disabled, or leave, and the business typically owns life insurance on each owner to fund the purchase. It is also called a stock redemption agreement in a corporation.
The structure exists to solve an arithmetic problem, and understanding that problem is what makes the rest of the design comprehensible. It also carries a federal estate tax exposure that most owners had never heard of until the Supreme Court decided a case in 2024, and any agreement drafted before then deserves a review.
This page explains why the structure was invented, what it fixed, what it broke, and how a policy owned under one of these agreements should be handled when the business no longer needs it. Nothing here is legal or tax advice; a buy-sell agreement is a document to be drafted and reviewed by a business attorney and a CPA. Pine Lake Legacy provides education and a free policy review only, and does not purchase policies.
In This Article
Why It Exists: The Cross-Purchase Policy Count Problem
The older structure is the cross-purchase agreement, in which each owner personally agrees to buy the others’ interests and each owner personally owns a policy on each of the others. With two owners that means two policies, which is manageable. With four owners it means twelve. With six owners it means thirty. The general formula is n times n minus one, and it becomes unworkable quickly.
Beyond the count, cross-purchase creates practical friction. Each owner pays premiums individually out of after-tax dollars. Younger owners subsidize the cost of insuring older ones. When an owner leaves, the policies they held on everyone else have to be dealt with, which raises transfer questions. And an owner in poor health can be difficult to insure, leaving a gap.
Entity purchase solves the count with a single stroke: the business owns one policy per owner, so six owners means six policies. The business pays all the premiums from one account, the administration is centralized, and nobody has to chase five colleagues for premium checks. That simplicity is the reason the structure spread.
The trade is that the funding sits inside the company, which is where the tax exposure lives. See how a cross-purchase agreement compares for the alternative in detail.
What the Supreme Court Changed in 2024
In Connelly v. United States, decided June 6, 2024, the U.S. Supreme Court held that life insurance proceeds a corporation receives to fund an obligation to redeem a deceased shareholder’s shares increase the corporation’s fair market value for federal estate tax purposes, and that the redemption obligation is not a liability that offsets those proceeds in the valuation.
The practical effect is direct. A company worth $3 million that receives $3 million of life insurance proceeds is treated as worth $6 million at the moment of the shareholder’s death, and the deceased owner’s proportionate share is valued against the larger figure. That can produce a materially higher estate tax valuation than the family expected and, in some cases, an estate tax bill the redemption price does not cover.
Every entity purchase agreement funded with company-owned life insurance and drafted before mid-2024 should be reviewed by a business attorney and a CPA in light of that decision. The response options commonly discussed include converting to a cross-purchase structure, using an insurance LLC or a trusteed cross-purchase to hold the policies, or restructuring the obligation. Each has its own tax consequences and none is a default answer.
Note that this is a federal estate tax issue, so it bites hardest in estates large enough to be taxable, and the federal exclusion amount changes with legislation. Confirm the current exclusion and your exposure with your CPA rather than assuming from any figure published in an earlier year.
| Feature | Entity Purchase | Cross-Purchase |
|---|---|---|
| Who buys the departing interest | The business | The remaining owners individually |
| Policies needed for n owners | n | n times (n minus 1) |
| Who owns and pays for the policies | The business | Each owner |
| Basis step-up for survivors | Generally no | Generally yes |
| Proceeds affect company value at death | Yes, per Connelly v. United States (2024) | No |
| Administrative burden | Low | High as owner count grows |
The Two Tax Rules That Punish Careless Restructuring
The transfer-for-value rule. Internal Revenue Code section 101(a)(2) provides that where a life insurance policy is transferred for valuable consideration, the death proceeds are generally taxable to the extent they exceed the consideration paid plus subsequent premiums — converting a tax-free death benefit into taxable income. The statute contains exceptions, including 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.
This matters enormously to anyone reacting to Connelly by moving policies out of a corporation into the hands of individual owners. Notably, transfer to a co-shareholder of the insured is not among the listed exceptions, which is precisely why partnership and LLC structures are used to hold policies in restructured cross-purchase arrangements. Do not move a policy without running this analysis with a tax professional first. See how the transfer-for-value rule works.
The employer-owned life insurance rules. Internal Revenue Code section 101(j), added by the Pension Protection Act of 2006, provides that death benefits on employer-owned life insurance are taxable above the employer’s basis unless notice and consent requirements were satisfied before the policy was issued and an exception applies — typically for a director, a highly compensated employee, or a policy payable to the insured’s family or used to buy an equity interest. Compliance is reported annually on IRS Form 8925.
The notice and consent must have happened before issue. It cannot be cured afterward. Any business holding policies on owners or key employees should confirm that the signed notice and consent forms exist and are in the file, and that Form 8925 is being filed. This is one of the most common and most expensive compliance gaps in closely held business insurance.
The Structures It Is Confused With
Cross-purchase agreement. Owners buy from each other and own the policies individually. Higher policy count, but the surviving owners get a basis step-up in the interests they purchase — a real advantage that entity purchase does not provide — and the proceeds do not inflate the company’s value.
Wait-and-see buy-sell. A hybrid that defers the choice: the agreement gives the company a first option to redeem, then the owners an option, then obligates whichever party is designated. Drafted well, it preserves flexibility to respond to a change in tax law.
Key person insurance. The company owns a policy on a valuable employee and receives the proceeds to cover the disruption of losing them. It funds nothing and buys no ownership interest. Different purpose entirely, though the same section 101(j) notice and consent rules apply. See what happens to a key person policy when a business closes.
Split-dollar arrangement. A cost and benefit sharing arrangement between an employer and an employee on a single policy, governed by its own detailed regulations. Not a buy-sell mechanism.
One structural point that catches new owners: a corporation cannot generally insure a person it has no insurable interest in, and insurable interest is tested at issue rather than at death. See how insurable interest works.
What Happens to the Policy When the Business No Longer Needs It
This is the situation that brings most people to this page. An owner retires, the business is sold, a partner is bought out, or the agreement is terminated — and the company is left holding a permanent policy on a 71-year-old former owner with an annual premium nobody wants to pay.
Work through the questions in order. First, does the agreement say what happens to the policy on termination or on an owner’s departure? Many buy-sell agreements contain a provision giving the departing owner a right or an option to purchase the policy on their own life. That option is frequently valuable and frequently unexercised because nobody reads it.
Second, what is the tax consequence of each path? Transferring the policy to the insured is one of the statutory exceptions to the transfer-for-value rule, which makes it a comparatively clean route, but the transfer itself may be treated as compensation or a distribution with its own tax cost. This requires a CPA, not a rule of thumb.
Third, what are the actual options for the contract? The same four as always: keep paying, reduce the face amount to a sustainable premium, surrender for the cash value, or determine whether the policy has value in the secondary market. A corporate-owned policy can generally be sold like any other, provided the owner has authority to act and the corporate formalities — a board resolution or member consent — are observed. Buyers will ask for them.
The general market parameters apply: face amounts above roughly $100,000, insureds typically over 65, and a health change since issue are what make a policy of interest, and the process typically runs 60 to 120 days from first review to funded payment. Where the insured is healthy and the premium is affordable, keeping the policy is often the better answer. Our page on what to do with a buy-sell policy nobody needs covers the situation directly.
For an independent read on the contract itself, send the policy cover page and the most recent annual statement for a free, no-obligation review, or call (732) 978-9575. Pine Lake Legacy does not purchase policies. Every tax and corporate question above belongs with your CPA and your business attorney.
Frequently Asked Questions
What is the main advantage of an entity purchase over a cross-purchase?
Simplicity. The business needs one policy per owner instead of one policy per owner pair, pays all premiums from a single account, and administers everything centrally. With four or more owners the cross-purchase policy count becomes impractical, which is the original reason the entity structure spread.
What did Connelly v. United States change?
The Supreme Court held in June 2024 that life insurance proceeds a corporation receives to fund a share redemption increase the corporation’s fair market value for federal estate tax purposes, and the redemption obligation does not offset them. Agreements drafted before that decision should be reviewed with a business attorney and CPA.
Can we just move the policies to the individual owners?
Not without analysis. Internal Revenue Code section 101(a)(2), the transfer-for-value rule, can convert a tax-free death benefit into taxable income, and transfer to a co-shareholder is not among the statutory exceptions. Partnership or LLC structures are commonly used for this reason. Run it with a tax professional before transferring anything.
What is Form 8925?
The IRS form on which an employer reports employer-owned life insurance contracts under Internal Revenue Code section 101(j). The section also requires notice and consent signed before the policy was issued, which cannot be cured later. Confirm the signed forms are in your file and that Form 8925 is being filed annually.
Can a corporate-owned policy be sold in the secondary market?
Generally yes, subject to corporate formalities such as a board resolution or member consent, which buyers will require. The usual market parameters apply: a face amount above roughly $100,000, an insured typically over 65, and a health change since issue. Expect 60 to 120 days from first review to funded payment.
The buy-sell ended. What are our options for the policy?
First read the agreement, since many give the departing owner an option to buy the policy on their own life. Then choose among keeping it, reducing the face amount, surrendering for cash value, or a secondary-market review. Each has a different tax consequence, so involve your CPA before acting.
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Related Reading
- What Is A Cross Purchase Agreement
- Buy Sell Agreement Policy Unneeded
- Buy Sell Funding Partner Bought Out
- What Is The Transfer For Value Rule
- Business Closing Key Man Policy
- What Is Insurable Interest
- What Is Cash Surrender Value
- How Much Is My Policy Worth
Pine Lake Legacy does not purchase life insurance policies and does not provide legal, tax, or investment advice. Information provided is for educational purposes only. Eligibility for any option, including life settlements, is not guaranteed and depends on individual circumstances, policy terms, underwriting, and market conditions. Consult independent legal, tax, or financial professionals before making decisions regarding a life insurance policy.