Buy-sell structures — Cross-Purchase vs Stock Redemption.

A Buy-Sell Agreement is the mandatory legal mechanism that governs what happens to an agency owner's equity when a triggering event occurs — death, disability, retirement, divorce, voluntary sale, or involuntary transfer. Without a properly funded Buy-Sell Agreement, a multi-owner agency faces potentially catastrophic ownership disputes and forced distressed sales when any partner's circumstances change. This Tactical covers the two primary structures — Cross-Purchase and Stock Redemption — their tax and operational trade-offs, and the funding mechanisms that make them executable.

§ 01 · Purpose and trigger eventsWhat the agreement actually does.

A Buy-Sell Agreement establishes in advance who can buy the departing owner's equity (other owners, the entity itself, or approved third parties), at what price (typically via the Certificate of Agreed Upon Value, CAUV), under what circumstances (the trigger events), and how the purchase is funded (insurance, installment note, sinking fund).

Standard trigger events: death (most commonly funded with life insurance), total permanent disability (funded with disability insurance), voluntary retirement or withdrawal, voluntary sale or transfer to an outside party, involuntary transfer (divorce, bankruptcy, or creditor seizure), and termination for cause. Without a funded agreement, these trigger events create uncertainty for surviving owners (who may suddenly have an unwanted partner — e.g., the deceased owner's spouse), for the departing owner's estate (which may face illiquidity), and for the agency itself (which faces potential operational disruption during any ownership dispute).

§ 02 · Cross-Purchase AgreementThe Step-Up structure.

In a Cross-Purchase Agreement, each shareholder agrees to purchase the other shareholders' equity interests directly upon a triggering event. The buy-sell obligation runs between individuals, not between individuals and the corporation. Each owner purchases a life insurance policy on every other owner — the purchasing owner is the owner and beneficiary of the policy. On a trigger event, surviving owners use their policy proceeds to purchase the departing owner's shares from the estate. The surviving owners personally end up with more shares; the corporation is not involved in the transaction.

The Step-Up in Basis advantage.

The primary structural advantage of Cross-Purchase is the Step-Up in Basis. When surviving owners personally purchase the departing owner's shares, they receive a new tax basis in those shares equal to the purchase price. When the agency is eventually sold, their taxable gain is calculated from this stepped-up basis, potentially saving significant capital gains taxes.

The N × (N-1) insurance problem.

The formula for the number of life insurance policies required in a Cross-Purchase Agreement is N × (N-1), where N is the number of owners. For a 4-owner agency this equals 12 policies. As owner count increases, administrative complexity compounds rapidly: 2 owners → 2 policies, 3 owners → 6, 4 owners → 12, 5 owners → 20.

The Insurance Policy Escrow solution.

To manage the administrative complexity of cross-ownership policies, agencies can use an Insurance Policy Escrow arrangement: a neutral third party (typically a CPA or attorney) holds all policies and the corresponding stock certificates in trust. On a triggering event, the trustee coordinates the policy proceeds distribution and stock transfer, ensuring the mechanism executes cleanly without requiring individual owners to manage 10+ policies personally.

Section 162 Executive Bonus — funding premiums tax-efficiently.

If funding premium payments through the agency (rather than from owners' personal funds), the agency can use an IRC Section 162 Executive Bonus arrangement: the corporation pays insurance premiums as a bonus directly to each owner-employee, deductible to the corporation as compensation expense. The owner-employee pays income tax on the bonus but uses the after-tax amount to pay the premium on the policy they own. The mechanism funds premiums without converting the policies into corporate-owned policies (which would create a Stock Redemption structure by accident).

§ 03 · Stock Redemption PlanSimpler — and the Basis Trap.

In a Stock Redemption Plan (also called an Entity Purchase Plan), the corporation itself — not the individual shareholders — is the buyer of the departing owner's shares. The corporation purchases, owns, and is the beneficiary of life insurance policies on all owners. N policies total, not N × (N-1). On a trigger event, the corporation uses policy proceeds to redeem the departing owner's shares. The corporation holds the reacquired shares as treasury stock; remaining owners' percentage ownership increases proportionally.

The Basis Trap.

The primary structural flaw of Stock Redemption is the Basis Trap. When the corporation redeems a departing owner's shares, the surviving owners do not receive a step-up in their own basis — their tax basis in their shares remains unchanged from what they originally paid. When the agency is eventually sold, the difference shows up.

Under Cross-Purchase, basis equals the stepped-up purchase price of the deceased or departing partner's shares (lower taxable gain). Under Stock Redemption, basis remains at original investment (higher taxable gain, more tax due). Over a long holding period, the Basis Trap can cost surviving owners hundreds of thousands or millions of dollars in additional capital gains taxes versus the Cross-Purchase structure.

The C-Corp AMT risk.

For agencies structured as C-Corporations, Stock Redemption structures create AMT exposure: life insurance death benefit proceeds received by the corporation are an "exempt preference item" that can trigger the corporate AMT (8.5% on adjusted taxable income above $1M). This is not a risk in S-Corps or LLCs, and is not a risk in Cross-Purchase structures (where individuals, not the corporation, receive the proceeds).

Dividend reclassification risk.

If the IRS determines that a stock redemption does not constitute a true sale (testing for "substantially disproportionate" redemption or "complete termination" of interest), proceeds may be reclassified from capital gains treatment to dividend income — taxed at higher ordinary income rates. Proper structuring with M&A counsel avoids this risk.

§ 04 · The CAUV — load-bearing for either structureThe price has to be agreed before the trigger.

The Certificate of Agreed Upon Value is the document — typically a one-page exhibit to the Buy-Sell Agreement — that establishes the agreed buyout price at any given point in time. Without a CAUV, the buy-sell price defaults to a potentially contested appraisal process at the worst possible time (immediately following a partner's death or disability). A contested appraisal delays buyout funding, creates legal expenses, and can destroy operational relationships among surviving owners.

The CAUV must be updated annually (or more frequently if the agency's value changes materially), typically signed by all owners as an exhibit to the Shareholders' Agreement. If the CAUV is not updated and becomes stale, it may be overridden by the courts in favor of a formal appraisal. Common valuation bases for the CAUV: fixed dollar amount (simplest; becomes stale fastest), formula-based (e.g., 2.5× trailing 12-month revenue), or EBITDA multiple (e.g., 6× Normalized EBITDA as calculated by the agency's CPA — note that this places the CAUV inside the canonical valuation framework, where 8–10× is the typical market band and 4–6× is the distressed-or-internal band).

§ 05 · Choosing between structuresThe selection framework.

Entity type: C-Corp (AMT risk in redemption) favors Cross-Purchase; S-Corp or LLC favors Stock Redemption. Owner count: 2–3 owners favors Cross-Purchase (insurance math still manageable); 4+ owners favors Stock Redemption (the N × (N-1) burden becomes operationally heavy). Long-term capital gains planning: high priority favors Cross-Purchase (Step-Up dominates). Administrative capacity: high favors Cross-Purchase; low favors Stock Redemption. Unequal health or insurability among owners: Cross-Purchase becomes expensive (older or unhealthier owners cost more to insure individually); Stock Redemption is simpler (the corporation buys all).

For agencies planning a future external exit, Cross-Purchase is almost always preferred because the Step-Up in Basis reduces the ultimate capital gains tax burden at the time of sale.

The Buy-Sell choice gets made at agency formation and lives for the agency's entire life. Most owners discover the trade-off they made decades earlier on the day the trigger fires. The right time to revisit either choice is now.

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