Cross-purchase agreement

A cross-purchase agreement is a type of buy-sell agreement in which the owners themselves, not the business, agree to buy a departing owner's interest. To fund the death trigger, each owner buys a life insurance policy on each of the other owners, pays the premiums and is the beneficiary.

Hypothetical example: three equal owners of a business valued at $3 million each own a $500,000 policy on each of the other two. When one owner dies, the two survivors each collect $500,000 tax-free and use it to buy half of the deceased owner's $1 million stake from the estate. Because the survivors paid for the shares, their tax basis rises by the purchase price, which can reduce capital gains tax if they later sell.

The structure has drawbacks. The number of policies grows quickly: with n owners you need n × (n − 1) policies, so five owners need 20. Owners with large age or health differences also pay very unequal premiums. A trust or partnership can hold the policies to simplify things, but the transfer-for-value rule must be considered whenever policies change hands. It is often weighed against an entity-redemption agreement; see cross-purchase vs entity-redemption buy-sell plans and funding a buy-sell agreement with life insurance.