The Connelly decision has changed the landscape of business succession planning, prompting producers to reexamine how buy-sell agreements funded with life insurance are structured. Traditional cross-purchase and entity-purchase agreements often fall short—the logistics can become too complicated, or the tax impact too onerous. While not as widely used as other buy-sell options, cross-endorsement buy-sell agreements are receiving more attention after Connelly as a flexible, tax-efficient alternative in complex ownership situations. Let’s take a closer look at how they work, where they fit best, and what you need to know to confidently discuss this option with business owners.
How Cross-Endorsement Agreements Work
In a cross-endorsement buy-sell agreement, each business owner purchases, owns, and pays premiums on a life insurance policy on their own life, with a death benefit equal to the value of their ownership interest. Instead of buying policies on each other—as in a traditional cross-purchase agreement—each owner endorses a portion of their policy’s death benefit to the other owners in the amount needed to buy out the deceased owner’s share. In return, the receiving owners pay an annual rental charge based on IRS or carrier tables that value the economic benefit of the endorsement. These rental charges are typically reviewed and updated each year with the help of the insurer.
If an owner dies, the surviving owners receive the endorsed death benefit and use the proceeds to purchase the deceased’s ownership interest. If the owners decide to terminate the agreement, the endorsements are removed, rental payments stop, and each owner can retain their own policy for personal planning purposes.
Why Cross-Endorsement Agreements Are Receiving More Attention
Because of the Connelly case, when the company owns the policies (entity-purchase agreements and wait-and-see agreements), there is now a potential tax impact. A well-crafted cross-endorsement agreement can offer the following advantages:
• Tax-free liquidity. The endorsed death benefit passes to surviving owners free of income tax, delivering immediate cash to fund the buyout.
• Estate tax protection. Because each owner holds their own policy, the proceeds don’t increase the company’s value and, in turn, enlarge the size of the deceased owner’s estate. This is especially relevant and advantageous after Connelly.
• Stepped-up basis. Surviving owners get a step-up in basis in the acquired shares of the business equal to what they paid, which helps minimize future capital gains exposure.
• Policy control. Each owner only needs to manage one policy, selecting the carrier, policy type, and riders that best fit their needs. Policies are portable if an owner leaves the company, and no ownership transfers are required if the agreement ends.
• Administrative ease. One policy per owner avoids the complexity of cross-purchase agreements, which may involve multiple policies, premium imbalances, and recordkeeping headaches. In addition, individual premium costs stay off the company books, simplifying accounting and corporate governance.
What to Watch Out For
As with any planning strategy, it is important to be aware of potential drawbacks and trade-offs, including the following:
• Nondeductible costs. Premiums and rental payments are treated as personal expenses, so they are not tax deductible for the owners.
• Transfer-for-value exposure. If the policy or endorsement is not handled correctly, it could trigger ordinary income tax on the death benefit (unless a specific exception applies).
• Extra tax reporting. The rental arrangement adds a layer of reporting that must be handled carefully each year to avoid missteps, audits, and penalties.
• Cash flow pressure. Owners are responsible for paying both their own premiums and the escalating rental charges.
• Estate tax issues. If the agreement isn’t structured carefully, the rents or endorsements could inadvertently increase an owner’s estate tax exposure.
None of these issues are dealbreakers, but they do require careful planning, coordination with tax and legal advisors, and regular reviews.
A Case Study: Planning Around Unequal Ownership
PurpleTech Solutions started as a small boutique software consultancy and quickly grew into a $12 million regional tech services firm. Its ownership reflects each founding partner’s unique role and initial investment:
• Avery owns 50% and leads business development as CEO.
• Jordan owns 30% and serves as CFO, managing capital and cash flow.
• Quinn owns the remaining 20% and heads up product innovation as CTO.
After Avery had a brief health scare, the partners realized they needed a plan to protect the business—and each other—in case something unexpected were to happen.
At first, they considered an entity-purchase agreement, where the business would own the policies and buy back the deceased owner’s interest. But that structure would have included the death benefit in the company’s value, potentially triggering estate tax issues and complicating the valuation of the remaining shares under the precedent set by Connelly.
They also looked at a cross-purchase agreement, where each owner would buy policies on the other two owners. But that would have required six separate policies and uneven premium obligations based on the value of each owner’s share.
Instead, they chose a cross-endorsement buy-sell agreement. Each partner owns a life insurance policy on his or her own life, proportionate to their share of the business, and endorses the appropriate amount to the other two partners, who pay the corresponding rental charges. If one partner dies, the surviving partners can use the policy proceeds to smoothly and efficiently purchase the deceased partner’s shares.
Final Takeaways
Cross-endorsement buy-sell agreements can be a smart, flexible alternative for businesses with multiple owners and unequal shares. A well-executed agreement offers:
• Tax-free liquidity just when it’s needed—without inflating the value of the business
• Simple administration, with just one policy per owner
• Greater control over policy design and ownership
• Tax advantages that help the owners minimize any estate tax or capital gains tax impact
Because of the rental structure and potential tax traps, precise drafting, careful implementation, and regular review are essential. Encourage clients to coordinate with tax and legal advisors to establish the right structure and keep it aligned over time.
Ultimately, this is a powerful planning tool for business owners—and a great way to start deeper conversations about succession planning and long-term protection.
