Estate Planning for Business Owners: Buy-Sell Agreements, Entity Freezes, and Key-Person Risk

Estate planning for a business owner has three jobs that ordinary plans do not: create a ready market for your ownership stake when you die or exit, control how the business is valued for a 40 percent estate tax, and protect the company from losing the person it depends on. The core tools are a properly structured and funded buy-sell agreement, valuation and freeze techniques that move future growth out of your estate, and insurance against key-person loss. The Supreme Court's 2024 Connelly decision changed how the most common buy-sell structure is taxed, and many agreements signed before it now need review.

Why is a buy-sell agreement the foundation?

A buy-sell agreement is a contract among owners, or between owners and the company, that fixes what happens to an ownership interest at death, disability, divorce, or departure. Without one, your heirs may inherit an illiquid minority stake with no buyer, no dividends, and no exit, while your co-owners inherit a partner they never chose. The agreement sets who must or may buy, at what price or formula, and on what terms, and it is typically funded with life insurance so the money exists exactly when the obligation arrives.

Two structures dominate. In a redemption agreement, the company itself buys back the deceased owner's interest, usually with corporate-owned life insurance. In a cross-purchase agreement, the surviving owners buy the interest personally, each holding policies on the others. A hybrid "wait and see" design lets the parties choose at the time of death.

What did Connelly v. United States change?

In Connelly v. United States, 602 U.S. 257 (2024), the Supreme Court unanimously held that life insurance proceeds a corporation receives to redeem a deceased owner's shares count as a corporate asset that increases the company's value for estate tax purposes, and the company's obligation to redeem the shares does not offset that value. In the case itself, two brothers owned a building-supply company that held $3.5 million of insurance on each of them to fund a redemption; the Court ruled the estate had to value the company inclusive of the insurance proceeds, raising the taxable value of the deceased brother's shares and the estate tax bill.

The practical lesson: a redemption agreement funded with corporate-owned insurance can inflate the very estate it was meant to pay out, taxing the family on insurance money that immediately leaves the company. For owners whose estates are near or above the $15 million federal exemption ($30 million per couple in 2026), this is not a technicality; it can add seven figures of tax.

Responses worth discussing with counsel include moving to a cross-purchase structure, where policies and proceeds sit with the surviving owners rather than inside the company; using a special-purpose insurance LLC or partnership to hold the policies, a structure designed to keep proceeds out of company value while solving the administrative mess of many owners holding policies on each other; or accepting redemption with eyes open where estates are safely below the exemption. Each path has its own income tax, basis, and creditor considerations, and transferring existing policies can raise transfer-for-value issues. Agreements drafted before June 2024 should be reviewed against Connelly regardless of which structure they use.

A related point: a buy-sell price does not automatically fix estate tax value. Under Section 2703, the IRS can disregard an agreement's price unless it is a bona fide business arrangement, not a device to transfer wealth to family at a discount, and comparable to arm's-length terms. Formula prices that have not been revisited in a decade are a common audit vulnerability.

How do valuation discounts and entity freezes work?

The estate tax falls on fair market value, and for private businesses that value is negotiable terrain. Appraisers routinely apply discounts for lack of control and lack of marketability when valuing minority or restricted interests, because a hypothetical buyer pays less for a stake it cannot control or easily sell. Gifting minority interests during life, properly appraised, lets owners move more business value per dollar of exemption. Discounts are fact-specific and draw IRS attention, so a qualified appraisal and consistent execution are essential.

A freeze goes further: it caps the value of your interest in the estate and routes future growth to the next generation. The most common version is a sale to an intentionally defective grantor trust. As a hypothetical, an owner sells a 40 percent non-voting interest in her S corporation, appraised at $12 million after discounts, to a grantor trust for her children in exchange for an installment note at the applicable federal rate. Her estate now holds a note of fixed value; if the business compounds at 10 percent, the growth above the note rate accrues to the trust, outside her estate. GRATs and, in the right facts, preferred partnership freezes serve similar ends. Chapter 14 of the Code (Sections 2701 through 2704) polices these techniques closely, so design quality matters more than ambition.

Freezes pair naturally with succession. Transferring non-voting interests lets an owner shift economics to children active in the business while retaining voting control until ready to hand it over.

What about key-person risk and liquidity for the tax itself?

Estate planning protects the family; key-person planning protects the enterprise the family's wealth depends on. Key person insurance owned by and payable to the company replaces lost profits, reassures lenders, and buys time to recruit successors after the death of a founder or rainmaker. It is distinct from buy-sell funding and is often the more urgent policy for a company dependent on one or two people.

The estate tax bill itself is a liquidity event. Federal estate tax is generally due nine months after death, and a family whose wealth is mostly a private company can face a large bill with no cash. Tools include Section 6166, which lets qualifying estates (closely held business interests exceeding 35 percent of the adjusted gross estate) pay the tax in installments over as long as 14 years; insurance held in an irrevocable life insurance trust, which keeps the death benefit out of the taxable estate while providing cash to the heirs; and pre-arranged credit. Planning the source of the tax payment is as important as minimizing the tax.

Key numbers for business owners in 2026

Frequently asked questions

Does Connelly mean redemption buy-sell agreements are dead?No, but they now carry a known estate tax cost for taxable estates, since corporate-owned insurance inflates company value without an offsetting deduction for the redemption obligation. Owners below the exemption may reasonably keep them; larger estates should evaluate cross-purchase or insurance LLC alternatives with counsel.

Will the price in my buy-sell agreement bind the IRS?Only if it satisfies Section 2703: bona fide business purpose, not a wealth-transfer device, and arm's-length comparability. Stale formulas and self-set prices are frequently disregarded.

How large are valuation discounts for minority interests?There is no fixed schedule; discounts depend on the appraisal, the interest's rights, and the facts, and the IRS challenges aggressive figures. A credentialed appraiser's report is the price of admission.

What if nearly all my estate is the business and there is no cash for the tax?Section 6166 installment relief, insurance owned in an irrevocable trust, redemptions under Section 303, and standby credit lines are the main tools. The worst plan is a forced sale of the company on a nine-month clock.

When should this planning start?Years before any exit or expected transition. Discounts, freezes, and QSBS positioning all work best on values that have not yet appreciated, and insurance requires insurability.

Do I need to coordinate my buy-sell with my estate documents?Yes. Wills, trusts, beneficiary designations, and the buy-sell must point the same direction; a trust plan that conflicts with transfer restrictions in the shareholder agreement creates litigation, not liquidity.