Buy-Sell Agreements: Tax Planning for Business Ownership Transitions

By Yarik Yarosh, CPA ·September 5, 2026 ·6 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

A buy-sell agreement is one of the most important documents for any business with multiple owners. It establishes a predetermined price and mechanism for transferring ownership when a triggering event occurs (death, disability, retirement, divorce, bankruptcy, or voluntary departure). Without a buy-sell agreement, surviving owners may face unwanted new partners (the deceased owner’s heirs), forced liquidation, or protracted legal disputes. From a tax perspective, the structure of the agreement determines whether the buyer receives a stepped-up basis in the acquired interest, how the purchase price is allocated among asset classes, and whether the proceeds are taxed as capital gains or ordinary income to the seller. The two primary structures are cross-purchase agreements (where the remaining owners individually buy the departing owner’s share) and entity-redemption agreements (where the business itself buys back the interest).

✓Key takeaway

Buy-sell agreement types:

Factor	Cross-Purchase	Entity Redemption (Stock Redemption)
Who buys	Remaining owners individually	The business entity
Funding source	Each owner buys life insurance on other owners	The business buys life insurance on each owner
Basis step-up for buyers	Yes (buyers increase basis by amount paid)	No (remaining shareholders’ basis unchanged)
Number of policies needed (N owners)	N x (N-1) policies	N policies
S-Corp impact	No effect on corporate income	Redemption reduces shareholder’s stock basis
Estate tax	Proceeds excluded from estate (if properly structured)	Proceeds may be includible in estate
Best for	2-3 owners, smaller businesses	4+ owners, simplicity preferred

Triggering events:

Event	Typical Treatment
Death	Mandatory buyout at agreed price
Permanent disability	Mandatory or optional buyout
Retirement	Mandatory or optional buyout (often with installment terms)
Voluntary departure	Right of first refusal to other owners
Divorce	Right of first refusal (prevents ex-spouse from becoming co-owner)
Bankruptcy	Mandatory buyout (prevents creditor from becoming co-owner)
Disagreement/deadlock	Shotgun clause or mediation

Valuation methods:

Method	How It Works	Best For
Fixed price	Owners agree to a specific dollar amount, updated annually	Simple businesses, updated regularly
Formula	Predetermined formula (multiple of earnings, book value, etc.)	Businesses with predictable earnings
Appraisal	Independent appraiser determines FMV at triggering event	Complex businesses, highest accuracy
Hybrid	Formula with appraisal as tiebreaker	Most businesses (recommended)

How do cross-purchase and redemption differ?

Hypothetical example

Round numbers. For current guidance, see 26 U.S.C. 2703 (buy-sell agreements for estate tax). An S-Corp with 3 equal shareholders (A, B, and C). Each owns 33.33%. The business is valued at $3,000,000. Each share is worth $1,000,000. Each shareholder’s basis in their stock is $200,000.

Shareholder A dies. The other two shareholders buy A’s share.

Cross-purchase agreement: B and C each buy half of A’s share ($500,000 each).

Buyer	Payment	New Basis
B	$500,000	$200,000 (original) + $500,000 (purchase) = $700,000
C	$500,000	$200,000 (original) + $500,000 (purchase) = $700,000

Tax to A’s estate:

Item	Amount
Sale price	$1,000,000
A’s basis (stepped up at death to FMV)	$1,000,000
Capital gain	$0

A’s estate pays no tax because the basis is stepped up to fair market value at death (IRC 1014).

Funding: B and C each own life insurance on A ($500,000 policies). The death benefit is tax-free (IRC 101). B and C use the insurance proceeds to fund the purchase.

Resulting ownership:

Shareholder	Ownership	Basis
B	50%	$700,000
C	50%	$700,000

Entity-redemption agreement (same facts): The S-Corp buys A’s shares for $1,000,000.

Item	Amount
S-Corp pays A’s estate	$1,000,000
A’s estate capital gain	$0 (stepped-up basis)

Resulting ownership:

Shareholder	Ownership	Basis
B	50% (1/3 of 2/3 remaining)	$200,000 (unchanged)
C	50%	$200,000 (unchanged)

The critical difference: basis.

Structure	B’s Basis	C’s Basis
Cross-purchase	$700,000	$700,000
Entity redemption	$200,000	$200,000

If B later sells their 50% share for $1,500,000:

Structure	Sale Price	Basis	Gain	Tax (20% LTCG)
Cross-purchase	$1,500,000	$700,000	$800,000	$160,000
Entity redemption	$1,500,000	$200,000	$1,300,000	$260,000

Cross-purchase saves $100,000 in taxes on B’s eventual sale because the basis was stepped up when B purchased A’s share.

Life insurance policy count:

Structure	Policies Needed (3 owners)	Policies Needed (5 owners)
Cross-purchase	6 (each owner insures the other 2)	20 (each owner insures the other 4)
Entity redemption	3 (company insures each owner)	5 (company insures each owner)

For businesses with many owners, entity redemption is simpler (fewer policies). The basis disadvantage can be mitigated with a “wait and see” buy-sell structure that gives the entity the first option to redeem, with remaining shares purchased by the other owners (getting cross-purchase basis treatment on the second portion).

Installment buyout (retirement trigger): A retires voluntarily. The agreement provides for a 5-year installment buyout with interest.

Year	Payment (principal + interest)	A’s Recognized Gain
Year 1	$220,000	Installment gain (gross profit ratio x payment)
Year 2	$220,000	Same
Year 3	$220,000	Same
Year 4	$220,000	Same
Year 5	$220,000	Same
Total	$1,100,000

The installment sale spreads A’s capital gain over 5 years, potentially keeping A in lower tax brackets each year.

Annual update requirement: The buy-sell agreement should be reviewed and the valuation updated annually. A fixed-price agreement set at $1,000,000 five years ago, when the business was worth $1,000,000, creates problems if the business is now worth $3,000,000 (the estate sells for $1,000,000 instead of $3,000,000, and the estate may challenge the agreement). The IRS may also challenge the valuation if it is not reasonably current.

Illustrative numbers only, not a real client and not advice for your facts.

What are the tax differences between a cross-purchase and entity redemption buy-sell agreement?

In a cross-purchase agreement, the remaining owners buy the departing owner’s interest directly, and each buyer gets a stepped-up basis in the purchased interest equal to what they paid. In an entity redemption, the business itself buys back the departing owner’s interest, which means the remaining owners don’t get a basis step-up (their percentage ownership increases but their basis stays the same). Cross-purchase agreements funded with life insurance can become unwieldy when there are many owners (each owner needs a separate policy on every other owner). Entity redemptions are simpler administratively but can trigger the accumulated earnings tax if the corporation retains excess funds for the anticipated buyout. For S-Corps, redemptions that don’t completely terminate a shareholder’s interest are treated as distributions (potentially taxable as dividends from accumulated E&P), not as sales, which can produce unfavorable tax results.

Related guides:

Family Business Succession: Tax-Efficient Methods for Transferring a Business…
Tax Implications of Business Succession Planning: Family Transfers, Buy-Sell …
Estate Tax Planning for Small Business Owners

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Cite this page

Yarik Yarosh, CPA. "Buy-Sell Agreements: Tax Planning for Business Ownership Transitions." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-buy-sell-agreement-tax-planning

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.