The Buy-Sell Mistake That Almost Cost Millions in Taxes

Most business partners I talk to feel good about their buy-sell. They signed the agreement years ago. There's some life insurance in place. They think the box is checked.

But "having a buy-sell" and "having a buy-sell that actually works" are two very different things. The gap between them can be measured in millions of dollars of unexpected tax liability — and you usually don't find out until it's too late to fix.

Let me tell you about a real situation. Names and details are changed, but the structure is exactly as it happened.

The Setup

Two partners. A successful business — not a startup, an established company with real value. Eight figures. They'd been running it together for 15 years. They had a buy-sell agreement drafted by a competent attorney years earlier. They had life insurance policies on each other to fund it. They reviewed it periodically, or thought they did.

What they hadn't done was stress-test the ownership structure against the current value of the business.

When the business was worth two million dollars, the estate implications were manageable. When it grew to be worth significantly more, the structure they'd built became a liability. Specifically: the life insurance policies were owned by the company in a way that, combined with the buy-sell mechanics, would have pulled the death benefit proceeds into the taxable estate of the surviving partner. At the business's current value, the estate tax exposure on a triggering event was enormous — millions of dollars that would have gone to the IRS instead of the families.

An estate planning attorney found it during a routine review. Not the original buy-sell attorney. Not their CPA. An estate planner who was looking at the whole picture.

The Fix

The corrections weren't exotic. They weren't expensive. They were structural changes that required the right professionals to coordinate — which is the part that almost never happens.

First, they established an Irrevocable Life Insurance Trust, or ILIT, to own the policies. This moves the death benefit outside the taxable estate entirely. The trust pays the premiums, the trust receives the death benefit, and the IRS doesn't have a claim on it.

Second, they restructured from an entity-purchase design to a cross-purchase design. In a cross-purchase, each partner owns a policy on the other partner personally (or through the trust), rather than the company owning both policies. This matters for step-up in cost basis — which affects the capital gains exposure when the surviving partner eventually sells their interest.

These two changes — ILIT plus cross-purchase — took the estate tax liability to zero on the current facts. The business had grown. The risk had grown with it. The fix brought the structure back into alignment.

The Policy Design Inside the Buy-Sell

Here's the part that connects to how we think about the storehouse.

Once the structure was corrected, they also revisited how the policies themselves were designed. The original policies were standard — not overfunded, not designed for cash value. They covered the death benefit trigger but did nothing for the partners in the meantime.

We rebuilt the policies as overfunded designed contracts. Year-one cash value at approximately 90 cents on the dollar. Which means almost immediately, the partners had a significant pool of accessible capital inside their buy-sell structure. They could draw it back into the business as needed. They could use it for deal capital, for a bridge, for anything — while the death benefit protection remained fully intact.

The buy-sell policy stopped being a pure insurance product and became a working asset in their business. That's the difference between a policy that sits on a shelf and one that participates in the financial life of the business every year.

The Questions Every Business Partner Should Be Asking

If you have a business partner, these are the questions I'd want you walking into your next attorney and insurance review with:

Who owns the policies? The company, the partners personally, or a trust? The answer affects taxes in ways most buy-sell agreements don't address clearly.

When was the coverage amount last updated? If your business has grown since you set up the buy-sell, the coverage is almost certainly insufficient. An outdated buy-sell is sometimes worse than none — it creates false confidence.

Is this an entity-purchase or cross-purchase structure? Both can work. But cross-purchase with an ILIT typically provides better tax outcomes for businesses with meaningful value. Your estate attorney should weigh in on which structure fits your situation.

What does the policy do between now and the triggering event? A well-designed contract builds cash value you can access. It shouldn't be a dead premium expense for 20 years.

The partners in this story were not careless. They were successful, smart, and attentive to their business. They just hadn't had anyone look at the intersection of business value, ownership structure, and insurance design all at once — until they did.

That review cost them nothing. The problem it found would have cost their families millions.