The Buy-Sell Agreement Is Signed. Is It Funded?
Two shareholders, 60/40, an agreement signed in 2016 with a valuation formula of five times trailing EBITDA. The company has roughly tripled since then, the minority owner is 64, and you are preparing the return for the ninth consecutive year. Nothing in that engagement asks whether a dollar sits behind the obligation the agreement created.
The document and the funding are two separate questions. The first one gets answered at signing. The second one gets answered at a death, which is a terrible time to find out.
The Agreement Creates the Obligation. It Does Not Satisfy It.
The obligation is enforceable whether or not anyone ever set aside the money, and the failure mode is not a badly drafted agreement. It is a well-drafted agreement with nothing behind it. Someone — the company, the surviving owners, or a trustee — is on the hook for a defined price on a defined trigger, and nobody funded it. The trigger occurs, the surviving owner discovers the purchase price is real and the cash is theoretical, and the company either borrows against itself at the worst possible moment, issues a long-term note to a family that wanted liquidity, or renegotiates the whole thing with a widow across the table. The agreement was never wrong. It was never funded.
The valuation side ages just as quietly. As the CPA Journal's review of buy/sell agreements puts it, once owners enter into an agreement it may never be reviewed again, and after a few years the dollar amounts — or even the ownership percentages — no longer reflect reality. A formula set against a $4 million company does not describe a $12 million one. When the formula is stale and the funding is absent at the same time, what was designed as a mechanical calculation becomes a negotiation.
There is a second consequence to a formula nobody revisits. A price set in a buy-sell binds the parties by contract, but it only binds the Service for transfer tax purposes if the arrangement clears Section 2703 — a bona fide business arrangement, not a device to transfer value to family for less than full consideration, and terms comparable to what unrelated parties would accept. Where the parties are related, an agreement drafted in 2016, never updated, pricing a company at a fraction of what it would fetch today, is exactly the fact pattern those requirements were written to catch. The client's expectation is that the formula settles the number. It may only settle the number between the parties.
The population is larger than it looks. Gallup's survey of 1,264 U.S. business owners found 55% either plan to close the business or have no plan at all. A signed buy-sell puts a client in the better half of that distribution. It does not tell you the obligation is covered.
After Connelly, How It Is Funded Is a Tax Question
For years the entity-redemption structure was the default because it is administratively simple: one policy per owner, owned and paid by the company, no cross-ownership to maintain. That simplicity now carries a cost the agreement itself does not disclose.
In Connelly v. United States, decided unanimously in June 2024, a corporation collected $3.5 million on a policy insuring its majority shareholder and used $3 million of it to redeem his 77.18% interest. The estate reported the shares at the redemption price. The Court held that the proceeds committed to the redemption were a corporate asset includable in the company's date-of-death value, and that the obligation to redeem was not an offsetting liability.
The company was valued at $6.86 million rather than $3.86 million, the shares at $5.3 million rather than $3 million, and the estate faced a $889,914 deficiency. The Tax Adviser's analysis reads the holding as extending to closely held entities generally, not just C corporations.
The practical consequence for a closely held book is narrow and concrete. The funding vehicle that was supposed to solve an estate liquidity problem can enlarge the taxable estate it was meant to cover. Cross-purchase arrangements, insurance LLCs, and special-purpose entities each avoid that result and each carry administration a two-owner company may or may not sustain. Baker Tilly's post-decision guidance walks through the tradeoffs. The point is not that one structure is correct. It is that structure selection moved out of the attorney's office alone and onto a list of things with tax consequences you will be asked about.
Most firms find this boundary in the middle of a client conversation, not before it. The useful version of that conversation happens when there is no client and no deadline in the room.
A Boundary Conversation is 30 minutes with JT and Luke — no pitch, no client names required — mapping where your firm's advice currently stops.
What the Return Can Tell You, and What It Cannot
You are closer to the answer than most of the client's other advisors, because some of it is already in front of you.
Premiums on a policy where the entity is directly or indirectly a beneficiary are not deductible under Section 264(a)(1), so entity-owned coverage generally surfaces as a nondeductible expense and a book-tax difference. A Form 8925 in the file tells you entity-level coverage on employees exists and that someone has been tracking consents. No 8925 and no nondeductible premium line, in a company with a signed agreement and a partner in his sixties, tells you either nothing is owned at the entity level or nobody has looked.
What the return will not show you is a cross-purchase arrangement funded with individually owned policies. Those premiums are personal, nondeductible, and appear nowhere in the entity's books. Silence in the file is not evidence of a gap. It is a reason for one question.
Two failures worth confirming when the coverage does exist. Under Section 101(j), employer-owned contracts issued after August 17, 2006 lose their income-tax-free treatment unless the notice and consent requirements were met before issuance and the arrangement fits a statutory exception — a covered insured, or proceeds paid to the insured's family or estate or used to buy out an equity interest. Notice 2009-48 allows a narrow correction for inadvertent notice-and-consent failures, but the window closes with the return for the year the contract was issued, which means a defect surfacing in year six is not fixable. And where a policy has changed hands — an owner buying out a departing partner's policy when a cross-purchase was restructured — the transfer-for-value rules can convert a death benefit into ordinary income. Both are discoverable now at almost no cost and undiscoverable later at considerable cost.
The Question Worth Asking in March
When the client is already sitting there and the file is already open, four questions cover it.
Whose obligation is it? Entity, individual owners, or a trustee. The answer determines which Connelly analysis applies.
What actually funds it? Insurance, a sinking fund, a note, or an assumption that the bank will lend. The last one is not funding.
When was the formula last run against real numbers? Not when was it last read. When was it last calculated.
Does the client know what happens if the trigger is disability rather than death? Many agreements cover one and not the other, and a disability trigger is not the remote case owners assume it is.
A related distinction gets collapsed constantly in client conversations. Key person coverage replaces earnings the business loses when someone stops working. Buy-sell funding buys an ownership interest. A company can hold one and be entirely unprotected on the other, and an owner who remembers signing something about insurance years ago usually cannot tell you which one he signed.
None of that requires a new capability. It requires asking, which puts you in the room when the client decides what to do next.
That next step is where firms diverge. Some build the capacity in-house, which means hours out of a week that already contains the returns. Some refer it out, which is fast and clean and occasionally ends with the client's planning relationship living in someone else's office. Some coordinate — the specialist works inside the frame you set, the structure comes back to your desk before it goes to the client, and you stay the advisor of record because you never left the room. That is the same judgment call that shows up wherever the tax return stops and the plan begins, and a funded buy-sell is simply its most literal form.
For an owner who is charitably inclined and heading toward a transaction rather than a death, the same unfunded-plan problem shows up on a compressed timeline — the window before a business sale closes early, and the structuring conversation has a deadline the client rarely sees coming. And for the client whose estate is now comfortably inside the permanent $15 million exemption, the exemption removed a filing problem without producing any cash. The obligation to buy out a partner is due when it is due.
The agreement in the binder is not the plan. It is the description of a plan, and somewhere in your book is a client who believes those are the same thing.
You do not need to build a new capability to solve this for a client. You need one conversation to see whether coordination does it better than a referral would.
The question isn't whether your clients need this. It's whether they get it from someone who keeps you in the room.
J.T. Hardcastle is a Partner at Sage & Main who helps families and business owners align their wealth with their values through tax-smart planning and intentional generosity.
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