Two partners co-own a $4 million dental practice. One dies Saturday. By Monday, the surviving partner faces the deceased's spouse, who wants cash now and threatens to sell her share to a competitor. The insurance solutions that prevent this are exactly what C.24 tests.
A buy-sell agreement is a binding contract that controls what happens to a business interest when an owner dies, becomes disabled, retires, or exits. Without one, the deceased owner's interest passes to heirs who may have no expertise, no desire to participate, and every incentive to demand a cash buyout, forcing a fire sale or inviting unwanted partners. Life insurance is the most common funding mechanism because it delivers an immediate, tax-free lump sum at the triggering event.
HIGH-FREQUENCY: The cross-purchase versus entity redemption comparison (specifically the stepped-up basis advantage) appears on nearly every exam form. Know the basis rule and the policy count formula cold.
Each owner individually buys a policy on every other owner. At death, surviving owners collect the death benefit and purchase the deceased's interest from the estate.
Common mistakes
- Confusing which structure provides a stepped-up basis. Cross-purchase = stepped-up basis. Entity redemption = no basis change. The exam presents a sale scenario and asks which structure produces a lower capital gain. The answer is always cross-purchase. Trap: "Entity redemption provides a stepped-up basis because the entity purchased the shares", wrong.
- Miscounting policies. Cross-purchase = N x (N-1), not N-squared and not N x (N-1) / 2. Three owners need 6 policies, not 3 and not 9. Trap values for 4 owners: 16 (wrong), 6 (wrong), 12 (correct cross-purchase), 4 (correct entity).
- Confusing key person insurance with split-dollar. Key person: business owns, business benefits, compensates for economic loss. Split-dollar: shared arrangement, both employer and employee derive benefits. "The business is the beneficiary" = key person. "The death benefit is split" = split-dollar.
Bottom line
- Cross-purchase = stepped-up basis for survivors; entity redemption produces no basis change.
- Policy count: cross-purchase needs N x (N-1) policies; entity redemption needs N.
- Trusteed cross-purchase preserves the basis step-up with only N policies, the best fit for 4+ owners.
- Key person insurance: premiums not deductible, death benefit tax-free if Section 101(j) consent is obtained before issuance.
Exam shortcut
Policy count: N x (N-1) for cross-purchase, N for entity. Stepped-up basis = always cross-purchase. For split-dollar, identify the owner first: employer owns = endorsement, employee owns = collateral assignment. For Section 101(j), check timing, consent before the contract is issued. "Cross = Cost basis steps up", both start with C. "BOE Both ways, Key Person Neither way", BOE: deductible and taxable; key person: not deductible and not taxable.
The full lesson (about 2,242 words, 15 min read) adds 2 worked examples, all 5 common mistakes, a self-check, free in the app.
Learning objectives
- C.24
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