Cross Purchase Buy Sell Agreement

In cross purchase buy sell agreements, business owners agree among themselves to collectively purchase the interest of any owner who dies. Using life insurance policies to fund the buyout, each business owner purchases a life insurance policy on all the other owners. At the death of an owner, the surviving owners receive the policy proceeds and then purchase a pro rata share of the deceased owner’s business interest from his or her estate. The result is that the estate’s non-liquid business interest is converted into cash and the surviving owners now own 100 percent of the business.

Shareholder Consequences

Basis Increase. The surviving owners receive a step-up in basis in the purchased shares. This cost basis increase is the primary advantage of a cross-purchase buy-sell arrangement.

Capital Gain Treatment. With a lifetime sale, the selling owner recognizes capital gain to the extent the purchase price exceeds his or her basis.7 Upon an owner’s death, there is ordinarily no capital gain because the value of the shares receive a basis step-up to reflect fair market value — hopefully the same price received under the buy-sell arrangement.

Transfer for Value. Ordinarily, in a cross-purchase buy-sell arrangement, each shareholder owns a life insurance policy on the life of each of the other shareholders. Upon the death of the first shareholder, each of the remaining shareholders will use the proceeds of the policy they own on the life of the deceased shareholder to carry out their obligation to purchase a pro rata share of the deceased shareholder’s stock.

After this, the remaining shareholders will need to acquire additional insurance to fully fund their continuing obligations under the arrangement because each remaining shareholder will now own an increased portion of the business. If the remaining shareholders purchase the policies held by the estate of the deceased shareholder, the purchase will be a transfer for value. Sometimes the transfer-for-value rule can be avoided after the death of the first shareholder by allowing the deceased shareholder’s estate to sell policies (on the other shareholders) to the corporation and then converting the arrangement to an entity purchase buy-sell arrangement.

Complications. Where there are more than two or three owners, a cross-purchase buy-sell arrangement funded with life insurance can be complicated. The number of policies needed to fund the arrangement is typically equal to [(n-1)*n] when “n” is the number of owners. Because of the necessity of purchasing multiple policies, the entity purchase buy-sell arrangement is commonly used in situations where there are more than two or three owners. However, because of (1) the tax disadvantages of entity purchase buy-sell arrangements (primarily the lack of basis increase to the remaining shareholders), (2) the desire to avoid the purchase of multiple life policies, and (3) concerns regarding the consequences of the transfer-for-value rule, attorneys have created alternatives to the standard cross-purchase buy-sell arrangement. Two such alternatives, the “trusteed arrangement” and the “partnership arrangement,” are discussed in more detail below.

Corporate Consequences

No Alternative Minimum Tax (AMT) or Accumulated Earnings Taxes. Because the corporation does not own the policy, there are no potential AMT and accumulated earnings tax problems.

No Increase in Corporate Value. Life insurance (or other assets) used to fund the arrangement will not increase the value of the corporation. The value of life insurance policies (or other assets) will not be reflected on the corporation’s balance sheet. Although a cross-purchase buy-sell arrangement has no impact on the value of the corporation, the deceased shareholder’s estate will be increased by “funding” assets (such as the cash value of life insurance on the other shareholders) owned by the deceased shareholder.

How It Works

Establishing and Funding the Plan

1.       The owners of the Company establish a cross purchase buy sell agreement between themselves.

2.       Owner A takes out a life insurance policy on Owner B. Owner B takes out a life insurance policy on Owner A.

Cross Purchase Buy Sell AgreementEach is the owner, beneficiary and premium payer of a life insurance policy on the other.

At Death

3.       Assuming Owner A dies, the life insurance company pays Owner B the death benefit.

4.       Owner B uses the cash to purchase the business interest in the Company from Owner A’s estate.

Cross Purchase Buy Sell Arrangement


Surviving owner, Owner B obtains full control of Company and Owner A’s estate gets cash in exchange for the business interest.

Variations in Cross-Purchase Designs

Trusteed Cross-Purchase Arrangements

In a trusteed arrangement, a trustee purchases life insurance on the life of each shareholder who is a party to the arrangement. Upon the death of a shareholder, the trustee (1) collects the life insurance proceeds, (2) purchases stock from the estate of the deceased shareholder, and (3) distributes the shares to the surviving shareholders. The trustee may facilitate the transfer by holding the shares of each shareholder subject to the arrangement. It is uncertain whether the use of a trusteed arrangement avoids the transfer-for-value problem. The death of a shareholder could be construed as causing a transfer of the deceased shareholder’s beneficial interest in the policies on the lives of the survivors to the surviving shareholders for value.

Partnership Cross-Purchase Arrangements

Because the transfer-for-value rule may apply to a trusteed arrangement, the “partnership” arrangement has become popular. This arrangement is similar to the trusteed arrangement. However, instead of creating a trust, the shareholders form a partnership. The partnership then purchases a single life insurance policy on each shareholder. The partnership arrangement should avoid transfer-for-value problems because the transfer of a life insurance policy to a partnership in which the insured is a partner is an exception to the transfer-for-value rule. However, if the partnership is created exclusively (or  primarily) to facilitate the buy-sell arrangement, the IRS may not respect the validity of the partnership. Although the IRS approved of a partnership structured solely for the purpose of funding a buy-sell arrangement in PLR 9309021, the IRS subsequently adopted a no-ruling position on the use of partnerships to fund buy-sell arrangements in Rev. Proc. 96-12

In PLR 200747002, three business owners established an “Insurance LLC” (Limited Liability Company) to own life insurance policies on the lives of the business owners with management of the policies by an independent manager. The IRS ruled that the business owners would not have any incidents of ownership in the life insurance policies. Using an LLC with a cross purchase buy-sell agreement can also help the shareholders avoid a transfer-for-value problem, assure that the parties comply with the buy-sell agreement and keep the policy proceeds from the reach of the insured’s creditors.

Next Steps

Designing a business continuation plan is a crucial step to ensure your business remains intact at your retirement, death or other triggering event. Whether you leave your business by choice or by chance, you’ll leave your business on track and help provide for your family’s future. With an entity purchase (stock redemption) arrangement, you can help protect yourself, your business, co-owners and your family.

Talk to learn more contact an HNW Life Insurance Professional at (877) 579-9574 or submit an online request to schedule a time to discuss your particular situation.