Quick answer: A cross-purchase buy-sell agreement is structured so each co-owner personally owns and pays premiums on life insurance policies insuring the other owners. When an owner dies, surviving owners collect the insurance proceeds and buy the deceased's interest directly. The primary tax advantage: surviving owners receive a stepped-up cost basis equal to what they paid, reducing capital gains taxes significantly when they eventually sell.
Cross-Purchase vs. Entity Purchase — The Core Difference
There are two main buy-sell structures. In an entity purchase (stock redemption), the business owns the insurance and buys back the deceased owner's interest. Simple with two owners, but surviving owners don't get a stepped-up basis — they still have their original low basis when they sell later. In a cross-purchase, each owner holds policies on the others. In a 3-owner business, each owner holds 2 policies — 6 total. The surviving owners purchase the interest at current fair market value, giving them a high cost basis. When the business sells for $5M later, a higher basis means much less capital gains tax.
The Stepped-Up Basis Advantage Illustrated
Example: Three equal owners of a $3M business. Owner A dies. In a cross-purchase, B and C each pay $500,000 (from $500K life insurance proceeds) for A's 1/3 share. Their new basis in that portion is $500,000 each. Ten years later, the business sells for $6M. B and C's capital gain is calculated from their higher basis — potentially saving $75,000–$150,000+ in long-term capital gains taxes compared to if they'd used an entity purchase structure with no basis step-up. This basis advantage makes cross-purchase the preferred structure for S-corps, partnerships, and LLCs taxed as partnerships.
Practical Challenges with Multiple Owners
Cross-purchase gets complex with more than 2 or 3 owners. With 5 owners, each holds 4 policies — 20 policies total. Premium payments, beneficiary updates, and policy coordination become difficult to manage. The solution is often an insurance LLC or trust that holds all policies centrally. Also, if owners have significantly different ages or health status, premium amounts will be unequal, raising fairness issues. Some businesses use a hybrid structure or convert from one type to another. Consult an attorney and financial professional to determine which structure fits your ownership group.
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