Cross-Purchase vs. Redemption — structure, tax, and the post-Connelly shift.

Before June 2024, Cross-Purchase and Redemption were often presented as equivalent options. Partners chose based on administrative preference. After Connelly v. United States, the choice is no longer neutral. The Supreme Court held that life-insurance proceeds received by a corporation to fund a Redemption increase the fair-market value of the company for estate-tax purposes. The structural simplicity of Redemption now comes with a real tax cost.

§ 01 · Redemption — the agency buysSimple administration, real tax exposure.

Mechanics: the business entity (Corporation or LLC) is obligated to buy back ("redeem") the shares from the departing owner. The agency owns one life-insurance policy per partner. Three partners means three policies. Five means five. Simple to track.

The major advantage is administrative simplicity — one buyer, clean policy matrix, centralized management. The major drawback is two tax problems.

Problem 1 — no stepped-up basis. When the agency redeems the departing partner's shares, the remaining partners' ownership percentages increase, but their tax basis does not. When they eventually sell the agency, the capital gain is calculated against the original (low) basis. The tax cost compounds at exit.

Problem 2 — the Connelly ruling. The Court held that when a corporation receives life-insurance proceeds to fund a Redemption, those proceeds increase the fair-market value of the company for estate-tax purposes. If the agency collects $2M in life insurance to redeem a deceased partner's shares, the IRS can argue the agency is now worth $2M more — inflating the deceased partner's taxable estate. The family receives cash from the buyout but owes estate tax on the insurance proceeds. The funding mechanism designed to make the buyout tax-free creates a tax liability instead.

§ 02 · Cross-Purchase — the partners buyTax benefit, administrative complexity.

Mechanics: the remaining partners are individually obligated to buy the departing owner's shares. Each partner owns a life-insurance policy on each other partner. Three partners means six policies (A on B&C, B on A&C, C on A&B). Five partners means twenty. Ten partners means ninety.

The major advantage is the stepped-up basis. When a partner buys their departing partner's shares, the buyer's tax basis in those shares is what they paid. At eventual sale, the capital gain is calculated against the higher basis, reducing the tax bill significantly. On a multi-million-dollar exit, the difference can be six figures or more.

The major drawback is the policy matrix. Managing ten policies is manageable. Managing twenty is administrative chaos. Each partner must remember to pay premiums on multiple policies. Lapses are common. Adding a new partner requires multiple new policies. Removing a partner requires terminating multiple old ones. Industry reality: many firms attempt Cross-Purchase, fail to manage the policies, and the agreement becomes effectively unfunded.

§ 03 · Trusteed Cross-PurchaseThe hybrid that captures both benefits.

Partners create a separate entity — an Insurance Trust or LLC — to own and manage all the policies centrally.

How it works. The Trust owns one policy per partner (solving the administrative chaos). Partners contribute money to the Trust to pay premiums (the Trust pays from a central account; no individual responsibility to remember). On a partner's death, the Trust collects the proceeds and distributes cash to the surviving partners, who use it to buy the deceased partner's shares from the estate. Because the partners (via the Trust) own the policies — not the agency — the death benefit does not inflate the agency's value for estate-tax purposes. Surviving partners get the stepped-up basis in the shares they buy. All the Cross-Purchase tax benefits without the policy-matrix chaos.

The trade-off is modest cost for trust administration (approximately $2K–$5K annually). It is a bargain compared to managing 20+ individual policies, missing stepped-up basis opportunities, or facing Connelly-driven estate-tax exposure.

§ 04 · The Transfer for Value warningHow to switch structures safely.

If an agency currently has a Redemption structure and wants to switch to Cross-Purchase, the Transfer for Value rule matters. Under the doctrine, transferring a life-insurance policy from one entity to another (e.g., from the agency to individual partners) can make the future death benefit ordinary income to the recipient instead of tax-free proceeds.

The exception covers transfers to partners or partnerships, but the rule is technical and mistakes are costly. The clean path: do not transfer existing policies. Instead, cancel the old policies and issue new policies directly to the trust or partners. Allow a brief monitored coverage gap. Get written guidance from a tax attorney to confirm compliance.

§ 05 · When Redemption might still make senseThe narrow remaining use cases.

Despite the Connelly shift, Redemption may still be appropriate in specific scenarios. Very small agencies with two partners — the policy matrix is simple (two policies), administrative tax complexity may not justify a trust. Agencies in states without estate tax where the Connelly impact is muted (the federal exemption is high in 2026; state-tax risk is the binding concern). Agencies with very young partners where the exit timeline is long enough that tax planning becomes less urgent.

For most mid-sized to larger agencies, the math points to Trusteed Cross-Purchase.

§ 06 · The LLC and S-Corp considerationPass-through structures double the case for Cross-Purchase.

LLCs and S-Corps are pass-through entities for tax purposes — profits pass through to members'/shareholders' personal returns. This makes the stepped-up basis mechanism extremely valuable, since the basis adjustment carries through to personal taxation. For pass-through agencies, Cross-Purchase is nearly always the right choice. Trusteed Cross-Purchase is the optimal structure.

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