How Buy-Sell Structure Changes What the Survivors Pay in Tax

Separate the Owner, the Family, and the Business

“Survivors” can mean the remaining business owners or the deceased owner’s family. Their tax questions are different, and a result that benefits one party may not resolve the other’s needs.

Keep estate tax separate from income tax. Also distinguish the basis in an ownership interest from the business’s basis in its operating assets. A statement that “the basis steps up” is incomplete until it identifies the taxpayer and the property.

For the agreement and funding groundwork, see Buy-Sell Planning and Funding. This article focuses on the tax consequences of the structure chosen for that continuity plan.

Compare Who Actually Purchases the Interest

Cross-Purchase: The Remaining Owner Buys

In a cross-purchase, the surviving owner purchases the deceased owner’s interest. For a straightforward taxable stock purchase, the buyer generally takes cost basis in the purchased shares. 1

The buyer keeps the existing basis in their original shares and adds the basis of the newly purchased shares. That is a cost-basis result from a purchase—not an inheritance adjustment to everything the surviving owner already held.

Redemption: The Company Buys

In an entity redemption, the company purchases its own shares. The survivor’s percentage can increase even though the survivor has not personally purchased additional shares.

For the simplified C-corporation situation illustrated below, the company’s payment does not itself create purchase basis in the survivor’s remaining stock. Other facts can change the analysis, including the entity’s tax classification and how the transaction is implemented.

Do not choose a structure solely from that distinction. Ask who pays the premiums or purchase price, whose cash is depleted, what happens to the company’s value, and how the family is taxed. Higher basis is one input in the full comparison.

See the Basis Difference in a Simplified C-Corporation Example

Assume two unrelated owners each hold half of a C corporation. The surviving owner’s existing stock basis is $100,000. After the other owner’s death, an agreed $2 million payment purchases all of the deceased owner’s shares.

Compare two separate arrangements: the survivor pays $2 million personally, or the company pays $2 million to redeem the shares. Assume cash payments, no insurance-related basis adjustments, no other basis changes, and a properly respected transaction. The price is an assumed input, not an estate valuation conclusion.

The basis difference is $2 million. It is not a $2 million deduction or immediate tax saving. Basis is used to determine gain or loss in a later taxable disposition. 2

The economics also differ: the cross-purchase uses the owner’s cash, while the redemption uses company cash and reduces assets remaining in the company. The table does not claim that the survivor ends with equal wealth under both arrangements. It isolates why identical ownership percentages can conceal different tax records.

Do not apply these figures directly to an S corporation, partnership, or an arrangement involving policy transfers, debt, or other transactions. Those require their own calculations.

Understand What Connelly Changed About the Conversation

In Connelly v. United States (2024), a corporation received life insurance proceeds and used proceeds to redeem a deceased shareholder’s shares. The Supreme Court held that the fair-market-value redemption obligation did not offset those proceeds when valuing the corporation for the deceased shareholder’s federal estate tax. 3

The distinction is between paying for the shares and valuing the shares. Money can be committed to a redemption and still matter to the company’s value at death.

The Court discussed cross-purchase as an alternative in which insurance proceeds would have gone to the surviving shareholder rather than the company. It also recognized that alternative arrangements have their own drawbacks and tax consequences. The decision did not hold that every redemption obligation can never reduce corporate value. 3

For an existing agreement, ask the valuation professional, attorney, and tax adviser to show how company-owned proceeds affect the estate valuation and the required purchase payment. Do not assume that a policy amount selected years ago remains sufficient or that changing to cross-purchase is automatically the right answer.

Review the Family’s Income-Tax Result Separately

Property acquired from a decedent generally receives basis tied to its fair market value at death, subject to exceptions and applicable valuation rules. 2 The estate or beneficiary’s basis therefore may differ significantly from the deceased owner’s old basis.

That inherited basis does not automatically reset the surviving co-owner’s original shares. Nor does it mean the estate owes no estate tax. Those are separate analyses.

A Redemption Is Not Automatically Treated as a Stock Sale

Section 302 determines when a corporate redemption qualifies for exchange treatment. If the relevant conditions are not met, distribution rules can apply instead. Constructive ownership rules, including attribution of certain related parties’ holdings, can affect the determination. 4

Ask counsel to review the ownership remaining after the transaction, family relationships, trusts, and any applicable exception or waiver. A label in the agreement cannot replace that analysis.

Have the preparer identify the actual recipient of the payment and model the result using that recipient’s basis and tax circumstances. If payment is deferred, the timing and treatment of principal and interest need separate review. Avoid a blanket promise that a payment to the family will be tax free.

Account for the Entity’s Tax Classification

S Corporations Require a Basis Rollforward

S-corporation stock basis changes with pass-through items, including tax-exempt income, distributions, and certain expenses. 5 Qualifying tax-exempt life insurance proceeds can therefore affect shareholder basis through those rules; the allocation and timing need to be calculated.

The IRS Form 1120-S instructions specifically address reporting tax-exempt life insurance income and the limitations under Section 101(j). 6

A C-corporation statement that “the survivor gets no basis increase” should not be pasted into an S-corporation proposal without analysis. Ask for beginning basis, allocated income, relevant expenses and distributions, transaction adjustments, and ending basis for each affected shareholder.

Partnership-Taxed LLCs Need an Inside-and-Outside Basis Review

For an LLC taxed as a partnership, distinguish basis in the ownership interest from basis in partnership property. A Section 754 election can permit adjustments under Sections 734(b) and 743(b) following specified distributions or transfers. The IRS describes the election as generally due with a timely filed partnership return, including extensions, for the relevant year. 7

Have the preparer determine whether an election is already in effect, whether one should be made, whether any adjustment is mandatory, and which assets and partners are affected. A transfer between owners and a redemption by the partnership can invoke different rules.

“LLC” is a legal form, not a complete federal income-tax classification. Confirm how the entity is taxed before using any stock-basis comparison.

Review Policy Changes Before Acting on the Comparison

Moving an existing life insurance policy to support a different buy-sell structure can create a tax issue of its own. Section 101 contains transfer-for-value rules, exceptions, and special rules for reportable policy sales that can affect the exclusion of death benefits. 8

Do not assume a transfer is harmless because the insured stays the same or the agreement still serves a business purpose. Provide the policy’s ownership history, consideration, proposed transferee, and beneficiary to the tax adviser before submitting ownership changes.

Employer-owned life insurance also has separate requirements under Section 101(j), including applicable notice and consent rules. 8 A change intended to improve one tax result should not undermine the treatment of the funding source.

Compare the arrangement that actually exists with the proposed replacement. Include implementation costs, policy administration, premium responsibility, and the ability to keep coverage in force. The strongest basis result on paper may still be impractical if the parties cannot maintain the funding.

Request a Written Comparison Before Amending the Agreement

The useful deliverable is a side-by-side explanation of the current arrangement and realistic alternatives. Ask the professionals involved to cover:

1. The transaction. Who owns the interest before and after, who buys it, and which event triggers the purchase?
2. The money. Who owns the policy, receives proceeds, pays the price, and carries any remaining debt?
3. The valuation. How are proceeds and purchase obligations reflected in the contractual price and estate valuation?
4. The basis. What changes for the surviving owner, estate or beneficiary, and the business’s assets?
5. The tax treatment. Which amounts are taxable, when are they recognized, and what assumptions or elections support the result?
6. The implementation. Which documents, policy changes, filings, and records must be completed—and by whom?

Use the same underlying facts in each scenario, then make the funding differences visible. Do not compare one proposal that includes insurance, fees, and debt with another that omits them.

Revisit the analysis when ownership, entity tax status, business value, family circumstances, or policy arrangements change. The objective is a continuity plan with an understood tax result, not a generic rule that one structure always wins.

Common Questions

Sources and Tax Guidance

1. 26 U.S.C. Section 1012, the general cost-basis rule.
2. IRS Publication 551, basis, gain or loss, and inherited property.
3. U.S. Supreme Court: Connelly v. United States, June 6, 2024; redemption funding and estate valuation.
4. 26 U.S.C. Section 302, redemption exchange treatment and constructive ownership.
5. IRS: S Corporation Stock and Debt Basis, basis increases, decreases, and recordkeeping.
6. IRS Form 1120-S Instructions, tax-exempt life insurance income and shareholder allocations.
7. IRS: Section 754 Election FAQs, partnership basis adjustments and election timing.
8. 26 U.S.C. Section 101, life insurance exclusions, policy transfers, and employer-owned insurance.

Educational information, not individualized tax, legal, insurance, or investment advice. The example is hypothetical and isolates stock basis in a simplified C-corporation transaction. It is not an estate valuation, a projection of tax savings, or a comparison of equal economic outcomes. Actual treatment depends on entity status, ownership, funding, documents, elections, and applicable law.