Three Owners, One Uninsurable, and a Buy-Sell That Never Funds

Defects: the agreement is an unfunded promise. There is no valuation formula or appraisal mechanism, no funding source, no lifetime-transfer trigger for Doug's planned exit, no disability provision, and no treatment of an uninsurable owner. An unfunded buy-sell is a lawsuit waiting to happen among a widow, two survivors, and a company with no cash.

Cross-purchase (Priya's suggestion): with three owners this requires six policies - each owner insures the other two. Advantages: proceeds are income-tax-free to the individual buyers, and the surviving owners get a stepped-up basis in the purchased shares. Disadvantages here are real: the premium burden is regressive - Sam, with 50% of the equity, must carry policies on Priya and Doug, while Doug pays premiums on policies that protect others. In a 50/30/20 company the funding obligation and ownership do not line up.

Entity purchase (stock redemption): three policies owned by Ridgeline. Simpler administration, one checkbook, premiums roughly proportional to the value being redeemed. But the survivor gets no basis step-up, the corporation must consent to being insured and file Form 8925, and the death benefit exclusion is compromised if the notice-and-consent rules are missed. Also: if they start with an entity purchase and later move policies into a cross-purchase, co-shareholders generally fall outside the transfer-for-value exceptions - buy new policies rather than transfer old ones.

Split the problem into death and survival, because one policy from one carrier will not solve both.

Death before exit: fund what can be funded. The $250,000 table-rated policy covers about 30% of his $840,000 share. Pair it with a funded sinking fund - a fixed annual corporate contribution, or additional paid-in capital - sized to close the gap over the three-to-four-year horizon he has stated. Add a written installment-note provision so that any unfunded balance is paid to his estate over a defined term with stated interest, secured by the shares.

Survival to exit: a lifetime redemption or cross-purchase at a formula price, funded from cash flow and the sinking fund, with a defined payment schedule.

Underwriting revisit: do not treat the current offer as final. Re-shop at each anniversary; outcomes often change materially with a longer post-treatment interval and stable surveillance. Build the review into the plan rather than assuming a permanent decline.

Do not over-insure the two healthy owners to cover Doug's share. That shifts cost to Sam and Priya and creates an incentive problem. A written note, security interest, and a funded reserve are cleaner and enforceable.

If Ridgeline owns the policies, the arrangement is employer-owned life insurance under IRC §101(j):

• Before issuance, give each insured written notice that the employer intends to insure the employee's life, state the maximum face amount applied for, state that the employer will be the beneficiary of any proceeds, and state that the employee must consent in writing and that consent is binding on later transfers.
• Obtain written consent from each insured (and, for a survivorship policy, from each insured).
• Confirm an exception covers each insured - typically that the individual is a highly compensated employee, a director, or that proceeds are payable to a family member or to a trust for their benefit.
• File Form 8925 with the annual return, reporting the number of employees insured, aggregate face amount, and the employer's insured-life policyholder status.

Without valid notice and consent, the exclusion is limited to premiums paid - in a $4.2 million company that is a catastrophic result, and it would hit the survivors at exactly the moment the buy-sell must perform. A cross-purchase avoids §101(j) entirely, which is the usual reason to accept its higher policy count.