Buy-Sell Agreement Funding in Arizona: What Business Owners Must Know

Educational content only. SRG Consulting PLLC provides strategic education and coordination; consult your attorney and tax advisor before implementing any structure discussed here.

Most closely held businesses in Arizona have one of two problems with their buy-sell agreement. Either they don't have one, or they have one that was signed years ago, filed in a drawer, and never funded. The second problem is quieter but often worse — because the owners believe they're protected when they aren't.

A buy-sell agreement is a contract that determines what happens to an owner's interest when a triggering event occurs: death, disability, divorce, departure, or dispute. Buy-sell agreement funding is the mechanism that makes the contract executable. An agreement that obligates your partner's estate to sell you their 50% — but gives you no source of cash to buy it — is a promise without a wallet.

The Three Structures, and Why the Funding Question Comes First

Arizona business owners generally choose among three structures. A cross-purchase agreement has each owner personally buy the departing owner's interest, typically funded by life insurance policies the owners hold on each other. An entity-purchase (redemption) agreement has the company itself buy back the interest, funded by company-owned policies. A hybrid or "wait-and-see" agreement lets the parties choose the optimal path at the time of the triggering event.

The structure decision used to be driven mostly by administrative convenience — cross-purchase gets unwieldy past three or four owners because the policy count multiplies. But a 2024 Supreme Court decision changed the math in a way many Arizona agreements still haven't caught up with.

What Connelly Changed

In Connelly v. United States (2024), the Supreme Court held unanimously that life insurance proceeds received by a company to redeem a deceased owner's shares increase the company's value for estate tax purposes — and the redemption obligation does not offset that increase. In plain terms: with an entity-purchase structure, the insurance money the company receives to buy out your estate can inflate the taxable value of the very shares being bought.

For owners whose estates are comfortably below the federal exemption, this may be academic. For owners of appreciating companies — construction, contracting, professional practices, real estate-heavy operations — it is a live risk that compounds every year the business grows. Many agreements drafted before 2024 were structured as redemptions precisely because they were simpler. Those agreements deserve a fresh look.

The planning responses vary by situation: converting to cross-purchase, using a special-purpose insurance LLC to hold policies centrally while preserving cross-purchase treatment, or coordinating the buy-sell with broader trust architecture so the business interest never lands in the taxable estate at all. Which response fits depends on your entity type, owner count, and where the business sits in your overall succession plan — this is exactly where the buy-sell stops being an insurance question and becomes an estate planning question.

How Much Funding Is Enough?

Underfunding is the most common defect we see in existing agreements. The policy was sized to the company's value at signing — and the company doubled since. When the trigger hits, the insurance covers half the obligation, and the surviving owner is negotiating a promissory note with a grieving spouse for the rest.

Three practices prevent this:

• Anchor the valuation. Tie the agreement's valuation method to something determinable — a formula, an appraisal process, or an annually updated certificate of value — rather than a stale fixed number.
• Review on a cadence. Review coverage against current value every two to three years, or after any year of significant growth.
• Coordinate with key-person coverage. Buy-sell coverage and key person insurance solve different problems — ownership transfer versus operational survival — and companies routinely discover they bought one thinking it covered both.

The Arizona Angle

Arizona is a community property state. An owner's spouse may hold a community interest in the business whether or not they're named on the operating agreement — which means a buy-sell that never obtained spousal consent can be contested at exactly the wrong moment. Well-drafted Arizona agreements include spousal joinder provisions, and divorce triggers matter more here than owners expect. If your agreement was drafted out of state or without community property review, that's a specific item to raise with counsel.

Where to Start

If you own a closely held Arizona business, three questions tell you most of what you need to know. Does a signed buy-sell agreement exist? Is it funded with insurance sized to the company's current value? And has it been reviewed since the 2024 Connelly decision? If any answer is no, the fix is far cheaper before a triggering event than after one.

SRG Consulting works with business owners across Scottsdale, Phoenix, and the greater Arizona market to coordinate buy-sell design, funding analysis, and the surrounding succession and estate architecture — working alongside your attorney and CPA, not in place of them.

Not sure where your gaps are? Take the Business Owner Exposure Score — a 12-question assessment that measures your readiness across succession, protection, and wealth preservation — or contact us to schedule a buy-sell funding review.

Frequently Asked Questions

Sources & References

1. Connelly v. United States, 602 U.S. ___ (2024) — Supreme Court of the United States
2. Internal Revenue Code §2031, §303, §6166 — Estate tax valuation, redemption, and deferral provisions
3. Arizona Revised Statutes — Community property and entity governance statutes
4. Arizona Department of Insurance and Financial Institutions — Producer licensing and regulatory guidance