These factors offer guidelines for when each of these strategies may be suitable for businesses owned by three or more business owners.
When to use cross purchase or entity redemption strategies
BOLD sales support
Contact the Securian Financial Advanced Sales Team today.
1-888-413-7860, option 3
1. Type of business entity
Cross purchase
Step-up in basis for owners of C corporations (C corps) and pass-through
Entity redemption
Possible step-up in basis for owners of pass-through entities only
Basis increase for the surviving owners can be an important consideration. A detailed discussion of the characteristics of these entities is beyond the scope of this page.
What is important to know is that partnerships, S corporations (S corps), and LLCs (taxed as either a partnership or S corp) are pass-through entities, meaning that losses and profits are taxed directly to the owners.1 This becomes an issue when determining whether remaining owners will receive a step-up in basis for the purchase of a departing owner’s interest.
Entity redemption with a partnership — special allocation
Partnerships are pass-through entities similar to S corporations, so basis is also a key consideration. Like S corporations, a partner’s basis is affected by contributions, distributions and income or loss. But unlike S corporations with their ability to specially allocate income within a partnership, the basis discrepancy between entity redemption and cross purchase can be eliminated. See “Premium Allocation” within the lifecycle buy-sell strategy for a special allocation example.
2. Number of owners
Cross purchase
Requires each owner to own a policy on every other owner
Entity redemption
Requires one policy per owner
The entity redemption buy-sell strategy requires only one policy on each of the owners.
For seven owners, for example, seven policies are required. However, for a cross purchase buy-sell arrangement, each owner must own a policy on each of the other owners. In the example of a business with seven owners, 42 policies would be required.
Because of the immense administrative burden, cross purchase buy-sell arrangements are better suited to businesses with fewer owners.
3. Owner percentages, age and health
Percentages of ownership
Large variances in ownership interests will complicate buy-sell arrangements. When one owner has substantially more of the business than other owners, funding becomes problematic.
Cross purchase
Minority owners may not be able to afford life insurance premiums on the majority owner and may require additional bonuses to pay for the premiums
Entity redemption
Becomes an issue with S corps due to pass-through taxation. In an S corp, the minority owner may only receive a pro rata step-up in basis. If he or she owns 10% of the corporation, he or she will only get a 10% basis increase but may end up owning 100% of the corporation. Subsequent sale of the corporation may result in large capital gains tax exposure.
Age and health of owners
Healthy and/or young owners pay more to insure older and less healthy ones. This is particularly problematic in a cross purchase where policies are owned by the owners.
Combining retirement with buy-sell strategies
Cross purchase and entity redemption buy-sell arrangements can cause income taxation if the client is trying to combine retirement income strategies.
Entity redemption
In entity redemption, a business owns life insurance policies on the owners. If the owners were to retire or dissolve the business, the distribution of life insurance policies with cash value to the owners will be a taxable event. The taxation will depend on the type of business entity:
C corporation
Any life insurance policy distributions from a C corporation will be taxable to the recipient as a dividend or salary.
The amount taxable is the “fair market value.” At the point of distribution, the corporation must recognize any gain to the extent that the cash value of the policy exceeds the corporation’s premium payments. However, the corporation is entitled to a deduction (under Section 162) equal to the amount of distributed cash value the executive includes in income.
S corporation
If an S corporation provides a policy to the insured owner as a distribution, any gain will be recognized to the corporation as if the property were sold at fair market value. (Fair market value is generally considered the difference between the policy’s cost basis and its cash value without reduction for surrender charges.) All gains will pass through to the owner as ordinary income under the built-in gain rules.
Partnership
Generally distributions of property from a partnership to a partner are tax–free unless those distributions are considered compensation to the owner.
Cross purchase
In a cross purchase, business owners personally own policies on the lives of other owners.
At retirement, if the owners were to transfer the policies to the insureds, each owner would recognize taxable gain (the difference between the price they paid for the asset they are trading and the value of the asset they are receiving).
A owns a policy on B
$5,000 premium for 10 years = $50,000
cost basis and $80,000 cash surrender value (CSV)
B owns a policy on A
$5,000 premium for 10 years = $50,000 cost basis and $70,000 cash surrender value (CSV)
Tax ramifications of uncrossing the policies:
- Each has a cost basis of $50,000
- A has $20,000 taxable gain ($70,000 CSV - $50,000 cash basis)
- B has $30,000 taxable gain ($80,000 CSV - $50,000 cash basis)
This is a hypothetical example for illustrative purposes only.
Take BOLD action
Learn how to use BOLD with clients
Your business owner clients need life-stage specific tools. We’ll help you find the right solution.
View the step-by-step process1. IRC Sec. 1366.
Please keep in mind that the primary reason for purchasing life insurance is the death benefit.
Life insurance products contain charges, such as Cost of Insurance Charge, Cash Extra Charge, and Additional Agreements Charge (which we refer to as mortality charges), and Premium Charge, Monthly Policy Charge, Policy Issue Charge, Transaction Charge, Index Segment Charge, and Surrender Charge (which we refer to as expense charges). These charges may increase over time, and these policies may contain restrictions, such as surrender periods. Policyholders could lose money in these products.
Long-term care insurance may cover care such as nursing care, home and community-based care, and informal care. Please ensure that your clients consult a tax advisor regarding long-term care benefit payments, or when taking a loan or withdrawal from a life insurance contract.
Additional agreements may be available. Agreements may be subject to additional costs and restrictions. Agreements may not be available in all states or may exist under a different name in various states and may not be available in combination with other agreements.
Policy loans and withdrawals may create an adverse tax result in the event of lapse or policy surrender and will reduce both the surrender value and death benefit. Withdrawals may be subject to taxation within the first fifteen years of the contract. Clients should consult their tax advisor when considering taking a policy loan or withdrawal.
The Policy Design chosen may impact the tax status of the policy. If too much premium is paid, the policy could become a modified endowment contract (MEC). Distributions from a MEC may be taxable and if the taxpayer is under the age of 59 ½ may also be subject to an additional 10% penalty tax.
An annuity is intended to be a long-term, tax-deferred retirement vehicle. Earnings are taxable as ordinary income when distributed, and if withdrawn before age 59½, may be subject to a 10% federal tax penalty. If the annuity will fund an IRA or other tax qualified plan, the tax deferral feature offers no additional value. Qualified distributions from a Roth IRA are generally excluded from gross income, but taxes and penalties may apply to non-qualified distributions. Please consult a tax advisor for specific information. There are charges and expenses associated with annuities, such as surrender charges (deferred sales charges) for early withdrawals.
This information may contain a general discussion of the relevant federal tax laws. It is not intended for, nor can it be used by any taxpayer for the purpose of avoiding federal tax penalties. This information is provided to support the promotion or marketing of ideas that may benefit a taxpayer. Taxpayers should seek the advice of their own tax and legal advisors regarding any tax and legal issues applicable to their specific circumstances.
For financial professional use only. Not for use with the public. This material may not be reproduced in any form where it is accessible to the general public.
DOFU 10-2025
4784225