The folder is not the funding
A buy-sell agreement can sit quietly for years. The owners remember signing it. Nobody remembers whether the valuation was updated, who owns the policies, or whether the death benefit still matches the business.
Then an owner dies and every forgotten detail arrives at the same meeting.
A buy-sell agreement creates the purchase obligation; life insurance supplies cash when an insured owner dies.
The agreement decides who must buy, who must sell, and what the interest is worth. The policy puts money in a particular person’s or entity’s hands. The agreement needs to tell that recipient what transaction comes next.
Start with the agreement
The agreement should identify the triggering event, the buyer, the seller, and how the price will be determined. Life insurance enters after those terms are understood.
In a cross-purchase arrangement, owners may own policies on one another and use the proceeds to buy the deceased owner’s interest. In an entity-redemption arrangement, the business may own the policies, receive the proceeds, and redeem the interest itself. Other structures exist, especially when there are several owners or trusts involved.
None of those labels fixes a mismatch by itself.
If the agreement says a surviving owner must buy but the company receives the proceeds, the money may land in the wrong pocket for the promised transaction. If the business must redeem the shares but an individual owns the policy, the same problem runs the other direction.
The buyer under the agreement, policy owner, beneficiary, and intended use of proceeds need to describe one transaction.
Valuation decides how much cash the promise needs
The death benefit should follow the agreement’s valuation method. A fixed price written years ago can become stale. A formula can drift away from how the company is actually valued. An appraisal provision is useful only if the parties know when it is triggered and who completes the work.
Review the inputs that could move the obligation:
- current ownership percentages
- the agreement’s valuation method
- business debt and any guarantees tied to an owner
- existing policy amounts and ownership
- cash the business or surviving owners could contribute without hurting operations
- whether the policy is intended to fund all or only part of the purchase
Insurance can be deliberately partial funding. The problem is accidental partial funding, where the owners believe the full buyout is covered because a policy exists.
If the valuation changes, the coverage amount may need to change. If ownership changes, the policy structure may need to change too. Keeping those reviews together is less exciting than signing the original deal and much more useful.
Connelly made the valuation question harder to ignore
The United States Supreme Court’s 2024 decision in Connelly v. United States addressed a corporate redemption funded with company-owned life insurance. The Court held that the corporation’s obligation to redeem shares at fair market value did not offset the life insurance proceeds when valuing the company for federal estate tax purposes.
That was a specific estate-tax dispute, not a command that every business use one structure. It does mean owners should not assume insurance proceeds and a redemption obligation cancel each other out in the valuation.
Have the attorney who drafts or reviews the agreement and the accountant who handles the owners’ and business’s tax work examine the structure, valuation method, and intended funding together. This is where a neat insurance diagram can become a very untidy tax result.
Employer-owned coverage has its own paperwork
When the business owns life insurance on an employee-owner or another employee, federal employer-owned life insurance rules may apply.
Internal Revenue Service Notice 2009-48 explains the written notice and consent that generally must occur before issuance. The notice includes the intent to insure, the contemplated maximum face amount, and the fact that an applicable policyholder will be a beneficiary. The insured employee generally must consent in writing, including to possible continuation of coverage after employment ends.
Form 8925 annual reporting may also apply while qualifying employer-owned contracts remain in force.
Premium and proceeds should not be described with tax slogans. Internal Revenue Service Publication 334 says premiums generally are not deductible when the business is directly or indirectly the beneficiary. Whether death proceeds qualify for an income-tax exclusion can depend on ownership, transfer history, notice and consent, and how the arrangement is carried out.
The attorney and accountant need to review structure and tax treatment. The insurance policy should fund their documented plan, not improvise one.
Keep operating loss separate from ownership transfer
A buy-sell policy funds a purchase obligation. It may not leave the business enough cash to replace the person who died, keep customers, or cover the operating disruption.
Those are key person questions. The Key Person Is The One The Business Cannot Replace Quickly. explains how to estimate that separate operating loss.
The Business Life Insurance and Succession hub keeps both jobs visible. One amount may fund the ownership transfer. Another may give the company room to keep operating. Combining them without showing the math makes it hard to tell which promise is underfunded.
How to decide
If the agreement, valuation method, policy ownership, and beneficiary point to the same transaction, fund the measured obligation; if they do not, fix the documents before buying coverage.
Read the agreement first. Then put the right amount of cash in the hands of the buyer it names.