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How to choose — and when to use

When to use cross purchase or entity redemption strategies

These factors offer guidelines for when each of these strategies may be suitable for businesses owned by three or more business owners.

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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.

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1. IRC Sec. 1366.

Life insurance products contain fees, such as mortality and expense charges, (which may increase over time) and may contain restrictions, such as surrender periods.

Please keep in mind that the primary reason for purchasing life insurance is the death benefit.

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 10-2022