Starting a business with a partner is exciting, but even the strongest business relationships need a plan for the unexpected. What happens if an owner retires, becomes disabled, or passes away? Without a formal agreement, these events can create financial uncertainty, ownership disputes, and unintended tax consequences. A buy-sell agreement helps business owners prepare for these situations by establishing how ownership interests will be transferred and valued. It can also play an important role in business succession and estate planning.
What should a buy-sell agreement include?
A well-structured buy-sell agreement provides a framework for ownership transitions while helping protect the business and its remaining owners. Generally, these agreements address:
- Triggering events: Circumstances that initiate a buyout, such as death, disability, retirement, or an owner’s departure.
- Business valuation: How the departing owner’s interest will be valued.
- Purchase obligations: Who has the right or responsibility to purchase the ownership interest.
- Funding arrangements: How the buyout will be financed, often through life insurance or other available funds.
- Transaction timeline: When and how the ownership transfer will occur.
While these provisions can provide clarity, the agreement’s structure can also have significant tax implications, particularly when life insurance is used to fund a buyout.
How a Supreme Court ruling affects buy-sell agreements
The 2024 U.S. Supreme Court decision in Connelly v. United States highlighted an important estate tax consideration for businesses using company-owned life insurance to fund buy-sell agreements. The case involved two brothers who co-owned a business with an agreement allowing the surviving brother to purchase the deceased brother’s shares or have the company redeem them. To fund a potential redemption, the company maintained life insurance policies on both owners. When one brother died, the company received $3.5 million in life insurance proceeds and subsequently redeemed his shares for $3 million. However, the IRS argued that the insurance proceeds increased the company’s value and, consequently, the value of the deceased owner’s shares for estate tax purposes. The Supreme Court agreed, ruling that the company’s obligation to redeem the shares did not offset the value of the life insurance proceeds. As a result, the insurance proceeds increased the company’s fair market value for estate tax purposes.
The key takeaway is that life insurance intended to fund a buyout can also increase the taxable value of a deceased owner’s business interest, depending on how the agreement is structured. The ruling does not mean all insurance-funded buy-sell agreements create this result, but it reinforces the importance of reviewing existing arrangements.
Other tax considerations
Estate tax valuation isn’t the only concern. Business owners should also consider the potential income tax consequences of transferring life insurance policies. Under the transfer-for-value rule, transferring a life insurance policy in exchange for money or other valuable consideration may cause a portion of the death benefit to become taxable, unless an exception applies. Certain policy transfers may also be subject to additional reporting requirements. Other considerations, including ownership structure, state laws and income tax basis adjustments, can affect the overall tax outcome. Addressing these issues when drafting or updating an agreement can help prevent unexpected liabilities.
Review your agreement before you need it
A buy-sell agreement is more than a plan for transferring ownership. It’s an important part of protecting your business, preserving its value, and preparing for the future. Whether you’re establishing a new business or reviewing an existing agreement, it’s worth evaluating how your succession plan aligns with your tax and estate planning goals. SEK’s Estate Planning and Business Valuation professionals can help you evaluate your ownership arrangements, understand potential tax implications and plan for a smooth transition. Contact us to discuss your business succession planning needs.
© 2026
