Protecting Business Continuity with Buy/Sell Agreements Funded by Life Insurance: A Practical Guide for Business Owners

Avail Investment Partners
Jun 13, 2025
4 min read

Introduction

Business partnerships are often built on trust, collaboration, and a shared vision for growth. But what happens if one of the business owners dies, becomes disabled, or decides to exit the business? Without a clear plan, the consequences can be catastrophic: financial strain, legal disputes, and even business failure.

A buy/sell agreement funded with life insurance offers a proactive solution. This whitepaper walks through a real-world-style example using a $3 million business, compares various funding strategies, and highlights why the Buy/Sell LLC structure stands out as a tax-smart option.

Real-World Example: The Story of a $3 Million Business

Meet Chris, Jordan, and Taylor — co-founders of a thriving commercial painting business. When they started, it was just the three of them and a work truck. Over the years, their company grew into a $3 million enterprise with a full crew, dedicated office staff, and strong regional demand.

Each partner owns one-third of the business, with a pre-death cost basis of $200,000 each.

A Critical Event

One evening, Taylor is involved in a serious car accident. Recovery is uncertain. As Chris and Jordan scramble to keep operations afloat, they realize how interdependent the partnership is. What if Taylor doesn’t return? What if something worse happens?

They consult their wealth advisor and implement a Buy/Sell LLC funded with life insurance.

Structuring the Buy/Sell LLC with Life Insurance

To avoid financial and operational chaos in the event of death or disability, Chris, Jordan, and Taylor create a Buy/Sell LLC — a separate entity designed to own and manage the buy/sell life insurance policies.

Key Features:

The Buy/Sell LLC is taxed as a partnership.
Each partner owns 1/3 of the LLC.
The LLC purchases and owns one $1 million permanent life insurance policy on each partner.
Premiums are paid via capital contributions or tax-deductible bonuses from the operating company.

Trigger Event: Taylor Passes Away

The LLC receives $1 million in death benefit.
It purchases Taylor's 1/3 interest from the estate.
Chris and Jordan now own 50% each of the business.
Each surviving partner receives a step-up in basis for the interest acquired from Taylor.

Tax Impact: Step-Up in Basis

Before Taylor’s Death

Chris and Jordan each own 33.3%, with a basis of $200,000.

After Buyout

Each acquires 16.65% (half of Taylor’s 33.3%) for $500,000.
Their basis in that acquired portion steps up to fair market value.

Later, if the business is sold for $6 million, the step-up saves each surviving partner hundreds of thousands in capital gains taxes.

Are Life Insurance Proceeds Included in the Estate?

Whether life insurance proceeds are included in the deceased owner's estate depends on who owns the policy and who has control over it:

If the deceased owner owned the policy or retained incidents of ownership, the death benefit will typically be included in their gross estate for estate tax purposes (IRS, IRC Section 2042).
In a Buy/Sell LLC structure, where the LLC owns the policy and is the named beneficiary, the death proceeds are generally not included in the deceased owner's estate, assuming proper structure and no retained control.
However, if the deceased had control over the policy (e.g., the ability to change beneficiaries or borrow against it), the IRS may include the proceeds in the estate.

It's critical to work with tax and legal advisors to ensure the Buy/Sell LLC operating agreement and policy ownership are set up to avoid unintended estate inclusion.

Other Strategies to Fund a Buy/Sell Agreement

While the Buy/Sell LLC structure offers unique advantages, several funding methods exist for buy/sell agreements:

1. Cross-Purchase Agreement

Each owner buys a policy on every other owner.
Effective for two or three owners.
Can be complicated with four or more partners.

2. Entity Purchase (Stock Redemption)

The business buys and owns policies on the owners.
Simpler to administer, but no step-up in basis for surviving owners.

3. Redemption Agreement

Similar to an entity purchase, a redemption agreement is a type of buy/sell agreement where the business itself agrees to purchase the interest of a departing, disabled, or deceased owner.
The company may fund this agreement through life insurance.
Benefits include simplified policy ownership and control by the business.
Drawbacks include no step-up in basis for the remaining owners and potential exposure of the insurance proceeds to business creditors.

4. Self-Funding (Sinking Fund)

Business sets aside cash over time.
May take years to accumulate enough capital.
Doesn’t guarantee funds are available at the right time.

5. Borrowing to Fund the Buyout

Business or surviving owners take out a loan.
Creates debt and potential strain during an already difficult time.

6. Installment Purchase

Payments to the deceased owner’s estate are made over time.
May place significant financial burden on surviving owners or the business.

Conclusion

A well-designed buy/sell agreement is more than just a legal formality—it's an essential piece of business continuity and wealth preservation. When funded with life insurance and structured through a Buy/Sell LLC, the plan provides liquidity, tax advantages, asset protection, and peace of mind.

As a business owner, the time to plan is before a crisis occurs. Work with a financial advisor and legal team to ensure your agreement is funded, current, and tailored to your unique structure.