A buy-sell agreement answers three questions every business with more than one owner will face: who buys an owner’s interest when that owner dies, becomes disabled, or leaves; at what price; and with what money. Life insurance is the most common answer to the third question, because it delivers cash at the moment it is needed.
The first two questions determine whether the insurance works. The price depends on a sound business valuation. And since the Supreme Court’s 2024 decision in Connelly v. United States, who owns the policy can change the tax bill. This guide covers valuation basics, the ownership question, and a step-by-step process for putting a funded succession plan in place. I am an insurance broker, not an attorney or CPA, so use this as a guide to the decisions and have your own counsel confirm how the rules apply to you.
Value comes first. The insurance amount, the price in the agreement, and the tax result all start from what the business is worth.
Different valuation methods give different answers. In one sample report, five accepted methods valued the same company between $1.0 million and $3.58 million.
Who owns the policy matters. Since Connelly, insurance a company owns to buy back a deceased owner’s shares counts as company value for estate tax.
Disability is the most common gap. In one insurer’s review of 1,485 agreements, death was a mandatory buyout event in 70% of them and disability in only 33%.
Business Valuation Basics
Fair market value is the price a willing buyer and a willing seller would agree on, when neither is forced to act and both know the relevant facts. The IRS has long listed the factors an appraiser should weigh (Revenue Ruling 59-60): the nature and history of the business, the economic and industry outlook, book value and financial condition, earning capacity, goodwill and other intangibles, the size of the interest being valued and any prior sales, and prices of comparable public companies.
Valuation methods fall under three approaches. No single method fits every business, and appraisers often reference more than one.
Approach
What it measures
Best suited to
Asset
Assets, adjusted to current value, less liabilities. Often close to liquidation value.
Businesses with substantial equipment, inventory, or real estate
Income
What the earnings are worth to a buyer, by capitalizing past earnings or discounting projected cash flow
Businesses with consistent earnings; service firms where goodwill drives value
Market
Prices paid for comparable businesses
Industries with reliable sale data, which is harder to find for small firms and practices
One company, five values
Life insurers often prepare an informal valuation at no cost as a starting point for buy-sell planning. A sample report from Principal Financial Group shows how much the method matters. The sample company is a 12-year-old service business taxed as an S corporation, with two equal owners and no family relationship between them. Revenue was $14.09 million in the most recent year, book value was $1 million, and operating income averaged $686,000, weighted toward the most recent year.
Method
How it works
Result
Adjusted book value
Assets, with adjustments, less liabilities
$1,000,000
Discounted future cash flow
Earnings projected at 8% growth and discounted at 15%
$2,503,000
Capitalization of earnings
$686,000 of earnings divided by a 26% capitalization rate
$2,638,000
Excess of earnings
Earnings above a 4% return on assets, capitalized at 26%, plus book value
$3,485,000
Multiple of discretionary earnings
The same excess earnings times a multiple of 4, plus book value
$3,584,000
Sample company figures from an informal valuation report. The report highlights the last method as the most appropriate for a service business.
Three lessons follow from that table.
The assumptions carry the result. The capitalization rate, the multiple, and the growth rate are judgment calls. A small change in any of them moves the value by hundreds of thousands of dollars.
Owner compensation is adjusted. Pay above what the company would give a non-owner to do the same job is added back to earnings. The sample assumed none.
An informal valuation is a planning tool, not a tax value. It is useful for sizing insurance and starting the conversation. The price in the agreement, and any value reported to the IRS, should rest on a formal appraisal or a method your attorney and CPA have approved.
Using the highlighted value, each 50% owner’s interest is worth $1,792,000 today. At the report’s 8% growth assumption, that becomes about $2,633,000 in five years. Insurance bought to match today’s value will be short within a few years unless it is reviewed.
How Buy-Sell Agreements Are Funded
There are five ways to pay for a buyout. The same sample report compares their cost for a $1,000,000 purchase over 15 years, using a 45-year-old male in good health.
Funding method
Illustrated 15-year cost
The catch
Cash
$1,000,000
The cash must be on hand on an unknown date
Borrowing
About $1,187,000
Credit may be hardest to get just after an owner dies; repaid from earnings
Sinking fund
About $928,000
Only works if the owner lives long enough to fund it
Installment sale
Price plus interest
The departing owner’s family depends on the future success of the business
Life insurance
About $75,000 of premiums
The owner must qualify medically, and ownership must be set up correctly
Hypothetical carrier illustration from 2017. Actual premiums depend on age, health, product, and amount.
Insurance is the only method that creates the money when the event occurs. That is why death, and ideally disability, should be mandatory buyout events funded with coverage, while retirement and other departures are usually funded with installments, cash value, or savings.
Who Owns the Policy: The Connelly Decision
For decades the standard design was an entity redemption: the company owns a policy on each owner and uses the proceeds to buy back a deceased owner’s shares. In Connelly, two brothers used that design. The company collected $3.5 million on one brother’s death and paid his estate $3 million for his 77.18% interest. The estate valued the shares at $3 million. On June 6, 2024, a unanimous Supreme Court agreed with the IRS that the insurance proceeds were a company asset, and that the promise to redeem the shares was not a debt that offset them.
Estate’s position
IRS position, upheld by the Court
Value of the company
$3.86 million
$6.86 million, including the $3 million of proceeds used for the redemption
Value of the 77.18% interest
$3 million
$5.3 million
Cash the estate received
$3 million
$3 million
Additional estate tax
None
$889,914
The insurance bought to pay for the shares raised the taxable value of the shares it was buying.
What that means for the sample company
Apply the ruling to the two equal owners above. Each interest is worth $1,792,000, so the natural instinct is $1,792,000 of coverage on each owner.
Company owns the policy (redemption)
Other owner owns the policy (cross-purchase)
Company value at death
$5,376,000 ($3,584,000 plus $1,792,000 of proceeds)
$3,584,000
Estate tax value of the 50% interest
$2,688,000
$1,792,000
Cash the family receives
$1,792,000
$1,792,000
Value taxed but never received
$896,000
None
Before any valuation discounts. An equal 50% interest may qualify for smaller discounts than a minority interest.
Whether that $896,000 produces tax depends on the owner’s total estate. The federal exclusion is $15 million per person in 2026, so many estates owe nothing federally. State estate taxes start much lower. New York, for example, has a 2026 exclusion of $7.35 million and removes it entirely once an estate exceeds about $7.72 million.
Three ownership structures
Structure
Who owns the policies
Connelly exposure
What to watch
Entity redemption
The company
Yes
The price must include the proceeds for the family to be made whole, which increases the insurance needed
Cross-purchase
Each owner owns a policy on the other
No
Premium fairness between owners of different ages; the number of policies grows quickly with more owners
Insurance LLC taxed as a partnership
A separate LLC owned by the owners
No, if properly structured
Must be a genuine partnership with its own agreement and administration
A cross-purchase has a second advantage. The surviving owner who buys the interest receives a cost basis equal to the price paid, which reduces tax on a later sale. In a redemption, the survivor’s ownership percentage rises but basis does not.
A Step-by-Step Guide to a Funded Succession Plan
These steps are in the order I recommend. The first four are decisions made with your attorney and CPA. The insurance follows from them.
Step 1: Decide who succeeds and what triggers a buyout
Name the buyer for each owner’s interest: the other owners, the company, a family member, or a key employee. Then list the triggering events. Death and disability should be mandatory. Retirement, divorce, bankruptcy, and termination of employment should each be addressed, even if only with a right of first refusal. Every owner should be covered. An agreement that requires a buyout for one owner and leaves another owner’s interest to pass by will is half a plan.
Step 2: Establish what the business is worth
Start with an informal valuation to frame the numbers. You will need three years of revenue, operating income, depreciation, and owner compensation, plus book value. Before the agreement is signed, have the method reviewed by your CPA or obtain a formal appraisal.
Step 3: Write the pricing method into the agreement
Use a method, not a number. A common design is a certificate of value the owners sign each year, with an independent appraisal required if the certificate is more than 12 to 24 months old.
Use the same method during life and at death. A fixed price that applies only at death is a known weakness if the IRS reviews it.
Say how insurance is treated. State whether proceeds and cash values are included in the value.
Name who chooses the appraiser. An agreement that requires the shareholders to agree on a valuation firm does not work once one of them has died.
Step 4: Choose the ownership structure
With two or three owners, a cross-purchase is usually the cleanest answer after Connelly. With more owners, an insurance LLC keeps the number of policies manageable. A redemption can still be appropriate where estate tax is not a realistic concern, provided the agreement and the coverage are designed for it.
Step 5: Size the life insurance
Cross-purchase: coverage on each owner equal to the value of that owner’s interest. For the sample company, $1,792,000 on each owner.
Redemption: for the price to equal estate tax value, it must include the insurance. If the company redeems a fraction f of a business worth V, the face amount needed is f × V ÷ (1 − f). For a 50% owner of the sample company that is $3,584,000, twice the cross-purchase amount. For a 25% owner it is one-third of the business value.
Growth: build in room for the value to rise. Options include buying more than today’s value, adding coverage at scheduled reviews, or providing that any shortfall is paid in installments.
Step 6: Choose the type of policy and apply early
Policy type
Strength
Fits when
Term
Lowest cost for a set period
Owners expect to retire or sell within the term. Choose a policy that can be converted to permanent coverage without new medical underwriting.
Guaranteed universal life
Lifetime death benefit at a fixed premium, with little cash value
The need has no end date, such as a family business that will not be sold
Whole life or cash value universal life
Death benefit plus cash value
Cash value is wanted to help fund a buyout at retirement or disability
Apply before the agreement is final. If an owner cannot qualify, or qualifies only at a high cost, the funding plan changes, and it is better to know that while the document can still be adjusted. An independent broker can shop the case across carriers, which matters most when an owner has a health history.
Step 7: Fund the disability buyout
Disability buy-out insurance pays the purchase price when an owner is totally disabled, after a waiting period that is usually 12 to 24 months. The definition of disability in the agreement should match the definition in the policy, so the insurer’s decision triggers the buyout and the owners are not left to decide whether a partner is disabled. This coverage has its own underwriting and is not available for every business, so check availability early.
Step 8: Set ownership, beneficiary, and premium payment correctly
Owner and beneficiary should match the buyer. In a cross-purchase, each owner is owner, premium payer, and beneficiary of the policy on the other.
The business can still supply the cash. It can pay each owner a bonus to cover the premium. The bonus is taxable to the owner and generally deductible to the business. In an S corporation, distributions used for premiums must be proportionate to ownership.
Address premium fairness. A younger owner pays more to insure an older one. Owners often agree to adjust compensation to even this out.
Complete the paperwork for company-owned policies. For policies issued after August 17, 2006, the company must give the insured written notice and obtain consent before issue, and file Form 8925 each year. Without that, the death benefit above premiums paid is taxable to the company.
Step 9: Protect and retain key employees separately
Key person coverage and retention plans are different from buy-sell funding and should be documented separately. Company-owned key person insurance gives the business cash to recruit and train a replacement. Bonus and deferred compensation plans give key employees a reason to stay through a transition. Any promise to pay an employee in the future is a liability, and it should be measured, recorded, and reflected in the valuation.
Step 10: Coordinate with each owner’s estate plan
The agreement should say what happens when shares are held in a trust, and the trust should be eligible to hold them, which matters for S corporations. Personal coverage for estate liquidity is usually held in an irrevocable life insurance trust so it stays outside the taxable estate. Where some children work in the business and others do not, life insurance can provide an equal inheritance without dividing control.
Step 11: Review every year
Update the value, compare it to the coverage in force, and confirm that owners, beneficiaries, and premium payments still match the agreement. Review the full document whenever ownership, health, tax law, or the business changes materially.
Case Study: When the Steps Are Skipped
I recently reviewed the 2017 shareholders’ agreement and insurance of a long-established, closely held contractor. Names are omitted and some details are generalized. Two owners held the stock: a majority owner with 75% and a minority owner with 25%.
A fixed price, never updated (Steps 2 and 3). At the minority owner’s death, the company had to buy his shares for a fixed $600,000. A lifetime sale was priced at appraised fair market value. No one had revisited the number since 2017.
Company-owned funding (Step 4). The $600,000 came from a policy the company owned on his life, which is the Connelly pattern. After a 30% discount for a minority interest, his shares would be valued above the $600,000 his family receives whenever the business is worth more than about $2.83 million.
A one-way agreement (Step 1). The majority owner’s 75% passed to his trust or will, with no required buyer, no funding, and no successor director. His personal coverage was held correctly in an irrevocable trust, but that provides estate liquidity, not a succession plan.
No disability provisions (Step 7). Neither owner could be bought out if he became disabled.
Key employee promises that were never measured (Step 9). The company owned whole life policies on three long-tenured employees to fund agreements promising each the policy “proceeds” over 10 years. The agreements did not say whether that meant cash value or death benefit. Read broadly, the company owed about $1.09 million against roughly $425,000 of cash value.
None of these problems came from the insurance itself. Each policy was sound. The gaps were in the decisions the insurance was supposed to follow.
If You Already Have Company-Owned Policies
The instinct after Connelly is to transfer the company’s policy to the other owner. That can turn a tax-free death benefit into taxable income.
Transfer for value. When a policy is sold or exchanged for value, the death benefit generally becomes taxable above what the buyer paid. There are exceptions for 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. A transfer to a co-shareholder is not on that list.
Distributions. A policy distributed out of a corporation is generally taxable to the recipient at its fair market value.
Often simpler: new coverage. In many cases the cleaner path is a new policy owned in the right place from day one, with the old policy kept as key person coverage, transferred to the insured, or surrendered on the CPA’s advice. Insurability decides whether that option is available.
Not all company-owned insurance creates the Connelly problem. The Court addressed an obligation to redeem a shareholder’s own stock. Insurance that backs a promise to employees is offset by a real debt, as long as that debt is recorded. For a related ownership trap on the personal side, see The Goodman Triangle: Avoiding a Life Insurance Tax Trap.
Where an independent broker fits. I work alongside the owner’s attorney, CPA, and financial advisor. My part is the insurance: reviewing policies already in force, confirming ownership and beneficiaries against the agreement, sizing coverage to the valuation, and shopping new coverage across carriers. To start a review, contact us or call (866) 942-4181.
Frequently Asked Questions
Is an informal valuation enough for a buy-sell agreement?
It is enough to start planning and to estimate how much insurance is needed. It is not a substitute for a formal valuation and does not establish a value for tax purposes.
How much life insurance does a buy-sell agreement need?
In a cross-purchase, the value of each owner’s interest. In a redemption, more than that, because the proceeds themselves add to the company’s value. In both cases, plan for the value to grow.
Should we use term or permanent insurance?
Match the policy to how long the need will last. Term fits owners who expect to sell or retire within a known period. Permanent coverage fits a business meant to stay in the family or a buyout that could occur at any age. Many plans use convertible term so the decision can be revisited.
Does Connelly matter if my estate is below the federal exclusion?
It may not produce federal tax, but several states tax estates at much lower levels, exclusion amounts can change, and an agreement drafted today may not be tested for decades.
Does Connelly apply to LLCs and partnerships?
The case involved a corporation, but the valuation logic is not limited to corporations. An LLC or partnership that owns insurance to redeem a member’s interest should be reviewed the same way.
What if an owner cannot qualify for life insurance?
The agreement can fall back on an installment purchase, a sinking fund, or a smaller policy combined with a note. Underwriting results also vary by carrier, so one decline is not the final answer.
Principal Financial Group, sample informal business valuation report (2017): valuation methods, sample company figures, funding cost illustration, and review of 1,485 buy-sell agreements (January 2011 to January 2017).
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