Cross-Purchase vs. Entity Redemption Buy-Sell Agreement in Georgia

What Changed in 2024 — The Connelly Decision

Before diving into structure, this is the most important recent development in buy-sell planning. In June 2024, the U.S. Supreme Court decided Connelly v. United States — a case that changed how entity-owned life insurance is treated for estate tax purposes.

Before Connelly, entity redemption structures were common because the business held one policy per owner, which was administratively simple. The prior understanding was that the death benefit proceeds used to redeem a deceased owner’s interest would offset the estate tax value of that interest.

Connelly held that the life insurance death benefit increases the value of the business for estate tax purposes — and that increase is not offset by the redemption obligation. For a business owners in a taxable estate, this can create a significant unexpected estate tax bill. Every entity redemption buy-sell agreement in existence before June 2024 should be reviewed in light of Connelly.

How a Cross-Purchase Agreement Works

In a cross-purchase structure, each owner personally holds a life insurance policy on each other owner. When a triggering event occurs, the surviving owners use the policy proceeds to personally purchase the deceased owner’s interest from the estate.

Example: a two-owner business. Owner A holds a policy on Owner B. Owner B holds a policy on Owner A. When Owner A dies, Owner B receives the death benefit and uses it to purchase Owner A’s interest from Owner A’s estate. Owner B now owns 100 percent of the business. Owner B’s cost basis in the purchased interest is stepped up to the purchase price — which reduces capital gains taxes on a future business sale.

The stepped-up basis advantage is the primary reason cross-purchase structures are preferred for businesses where a future sale is anticipated.

How an Entity Redemption Agreement Works

In an entity redemption structure, the business itself holds a life insurance policy on each owner. When a triggering event occurs, the business uses the policy proceeds to purchase and retire the deceased owner’s interest. The surviving owners end up with a larger percentage of a company that holds less cash.

Entity redemption is administratively simpler for businesses with three or more owners — instead of each owner holding policies on every other owner, the business holds one policy per owner. For a five-owner business, a cross-purchase structure requires 20 policies; entity redemption requires five.

After Connelly, the tax disadvantage of entity redemption is more significant than it was before 2024. The death benefit that funds the redemption now increases the business valuation for estate tax purposes without an offsetting deduction for the redemption obligation.

The Tax Difference Between the Two Structures

The tax difference comes down to two issues: estate tax treatment of the death benefit (post-Connelly) and cost basis on a future business sale.

Estate tax (post-Connelly): In an entity redemption structure, the life insurance death benefit increases the business value for estate tax purposes. In a cross-purchase structure, the surviving owners receive the death benefit personally — it is in their hands, not the business’s — so it does not increase the business valuation.

Cost basis on future sale: In a cross-purchase, surviving owners purchase the deceased owner’s interest at fair market value, which becomes their new cost basis. When the business is eventually sold, their capital gains are calculated from that higher basis. In an entity redemption, the business retires the interest — the surviving owners’ cost basis in their original shares does not change. They pay capital gains on a larger gain when the business is sold.

S-Corp Restrictions

S-Corps add a layer of complexity to the structure choice. An S-Corp cannot have more than 100 shareholders, cannot have corporate or partnership shareholders, and all shareholders must be U.S. citizens or permanent residents. A trust that holds S-Corp shares must qualify as an Electing Small Business Trust (ESBT) or Qualified Subchapter S Trust (QSST).

In a cross-purchase structure, the life insurance policies are owned personally by the shareholders — no S-Corp eligibility issue. In an entity redemption structure, the S-Corp owns the policies. The insurance proceeds flow through the S-Corp and are subject to the pass-through tax treatment that applies to all S-Corp income. The interaction with each shareholder’s individual tax situation must be analyzed before choosing entity redemption for an S-Corp.

Which Structure Fits Your Business

For two-owner Georgia businesses where a future sale is anticipated: cross-purchase is almost always preferable. The stepped-up basis advantage and the post-Connelly estate tax risk both favor cross-purchase.

For three or more owners where administrative simplicity matters and no future sale is anticipated in the near term: entity redemption remains viable, but the Connelly estate tax risk should be analyzed for any owner whose estate may be taxable.

For S-Corps: cross-purchase avoids the S-Corp policy ownership complexity and the pass-through treatment of insurance proceeds.

See what a complete buy-sell agreement must cover beyond the ownership structure, and see what a buy-sell agreement costs in Atlanta for the flat-fee breakdown.