Cross-Purchase vs. Entity Redemption: Which One?

A unanimous Supreme Court decision in June 2024 rewrote the rules of buy-sell planning for business owners across the country. Connelly v. United States made one thing clear: the way many businesses have structured their buy-sell agreements — and funded them with life insurance — may now create significant, unexpected estate tax exposure.

If you’re an estate attorney, CPA, or financial advisor working with business owner clients, this is not a theoretical concern. It’s a pressing, real-world compliance issue that affects every existing buy-sell funded with business-owned life insurance. There is no grandfathering.

At Simplicit Financial, we are fiduciary life insurance specialists. Our job is to help advisors navigate exactly this kind of complexity — with no carrier bias and no competing interests. Here’s what every advisor needs to understand about post-Connelly buy-sell planning.

What Connelly Changed

Before Connelly, the prevailing assumption was that life insurance proceeds held by a corporation to fund a buy-sell redemption were essentially a wash: yes, the proceeds increased the business’s value — but they were offset by the company’s obligation to redeem shares from the deceased owner’s estate.

The Supreme Court rejected that logic entirely. In the actual Connelly case, Michael Connelly’s estate paid estate taxes on $5.3 million in shares — even though his family only received $3 million through the buyout. The $3.5 million in life insurance proceeds that flowed into the business increased the company’s value and, therefore, the estate’s tax bill. The redemption obligation did not offset it.

The lesson: insurance owned inside the business adds to estate value and is not cancelled out by a buy-sell obligation.

The Structure Decision: Cross-Purchase vs. Entity Redemption

CROSS-PURCHASE BUY-SELL

In a cross-purchase, individual owners — not the business — hold life insurance policies on each other. When one owner dies, the surviving owners use the insurance proceeds to purchase the deceased owner’s interest directly from their estate.

Because the insurance sits outside the business, Connelly doesn’t apply. The Supreme Court itself acknowledged that the Connelly brothers could have avoided their tax problem entirely by using a cross-purchase structure.

Best for: Businesses with 2 to 3 owners. Formula: (n)(n-1) = number of policies required. For 2 owners: 2 policies. For 3 owners: 6 policies. Beyond that, complexity grows significantly.

ENTITY REDEMPTION BUY-SELL (USE WITH CAUTION)

In an entity redemption, the business itself owns and is beneficiary of the life insurance policies. Upon an owner’s death, the company uses the proceeds to purchase (redeem) the deceased’s shares from the estate.

Post-Connelly, this structure carries meaningful estate tax risk for any owner with an estate tax exposure (federal or state). A conservative approach may avoid entity redemptions altogether, or carefully limit them to owners well below the estate tax threshold.

Alternative Connelly-Compliant Structures

For businesses where a simple cross-purchase isn’t practical, several sophisticated alternatives exist:

PASS (Partnership Administration Succession Strategy): A cross-purchase design using an insurance LLC. Requires only one policy per owner regardless of the number of owners — solving the policy proliferation problem for larger businesses. Owners must be structured as partners in a partnership to avoid transfer-for-value rule issues.

Insured-Controlled Cross-Purchase (ICCP): Each business owner holds a policy on their own life and endorses a portion of the death benefit to the other owners. When properly structured, this can remove the endorsed benefit from the business’s estate valuation. Careful legal and tax guidance is essential.

Endorsement Split-Dollar: Where unwinding an existing entity redemption is impractical (particularly if the policy’s cash value is in a gain position), an endorsement split-dollar arrangement with individual shareholders or an LLC may offer a path forward without triggering taxable gain.

What This Means for Advisors Right Now

Every business owner client with an existing buy-sell agreement funded by business-owned life insurance should have that agreement reviewed. There is no waiting period. There is no grandfathering. The Connelly ruling is the law and applies immediately.

As fiduciary life insurance specialists, Simplicit Financial works alongside estate attorneys, CPAs, and financial advisors to identify which structure is appropriate for each specific client situation — and to implement it properly. We bring no carrier bias and no AUM participation. We are aligned with you and your client, not with a product.

The question isn’t whether to act. It’s who’s going to be in the room when you do.