Buy-Sell Agreement Valuation Disputes: Why Buy-Sell Agreements Often Don't Settle the Value
Author: Redwood Valuation Content Team
Published: September 15, 2026
Most business owners assume their buy-sell agreement settles what the company is worth. Sometimes it does. Often it doesn't.
The same ownership interest can carry three different values at the same time, depending on who is asking. A co-owner may be bound by the price or valuation mechanism in an enforceable agreement. The IRS may not be. A judge in a shareholder or divorce case may not be either. A valuation provision drafted with one of those readers in mind can come apart in front of another because each of them may apply a different legal standard to the same set of facts.
The time to structure the agreement with those differences in mind is before a triggering event occurs. After a death, a divorce, or a departure, the agreement is what it is.
Three potential sources of dispute are:
The stated value is stale, set when the company was a fraction of its current size and never refreshed.
The valuation formula relies on book value, capitalized earnings, or some other shorthand that diverges from how unrelated owners in similar businesses actually negotiate price.
A triggering event (death, divorce, departure) sends the same number to two forums that apply two different standards.
These problems can overlap. A triggering event may expose both a weakness in the agreement's own pricing mechanism and a mismatch between that mechanism and the valuation rules a particular forum applies.
Three Forums Where Buy-Sell Prices Get Contested
Buy-sell valuation disputes can surface in at least three settings: an IRS estate examination, a state-court action by a departing owner or dissenting shareholder, or a divorce proceeding requiring valuation of the marital interest. The governing standards differ by forum and jurisdiction, which means the same buy-sell price may be binding in one setting and serve only as evidence in another. Federal transfer-tax law supplies a detailed statutory and regulatory framework for when a buy-sell price can control; shareholder and divorce outcomes depend on the governing state's statutes and case law.
IRS Estate Examination
An IRS examination asks whether a buy-sell agreement can fix transfer-tax value. Federal law generally requires specified rights or restrictions to be disregarded unless an exception applies, and for closely held stock the longstanding price-control authorities also matter. If the agreement price does not control, the interest is valued independently at fair market value under §2031. For closely held stock, Revenue Ruling 59-60 supplies the familiar valuation factors.
State-Court Shareholder or Dissenters' Action
When a shareholder exercises statutory appraisal rights after a corporate action, state corporate law generally supplies a state-law "fair value" or similar statutory standard rather than federal tax fair market value. Oppression or other shareholder-remedy actions are more variable: the available remedy and valuation standard depend on the particular state's statute and case law.
State-law fair-value determinations vary materially by jurisdiction and by the type of proceeding, including whether minority-interest or marketability discounts are prohibited, permitted, or otherwise reflected in the analysis. A buy-sell price may be relevant evidence or contractually binding in some circumstances, but it does not automatically control a statutory fair-value determination.
Divorce Proceedings
Family-law courts apply state-specific marital-property rules when valuing a business interest, so there is no single nationwide divorce standard. A buy-sell price may be relevant evidence, but whether it controls depends on the governing state law, the agreement's enforceability and applicability to the spouses, and the reliability of the stated price or formula as of the valuation date.
Goodwill shows how much divorce valuation can vary by state. Oregon distinguishes enterprise goodwill that belongs to the business from personal goodwill tied to the owner's personal services, reputation, or continued presence. Enterprise goodwill may be included in divisible business value; personal goodwill is not. Washington uses a different framework and recognizes professional goodwill as a divisible intangible asset when it exists and can be valued. The point is not that either rule is universal: the controlling state's law determines the treatment.
Why the Same Interest Can Produce Different Numbers
The three forums can produce different numbers because they ask different legal questions about value. Two of the resulting concepts are standards of value with legal definitions; the third is a contractual pricing concept.
Fair market value is the federal transfer-tax standard. Under IRC §2031 and Treas. Reg. §20.2031-1(b), it's the price at which property would change hands between a willing buyer and a willing seller, neither under compulsion to buy or sell and both having reasonable knowledge of relevant facts.
Fair value (as used in state shareholder-dispute actions) is a state-law concept and is not the same standard as federal tax fair market value. Its definition varies by jurisdiction and by remedy, as does the treatment of minority-interest and marketability considerations. Some appraisal statutes expressly exclude such discounts, while other proceedings apply different rules. A single state's fair-value definition is not a general rule.
Agreed value is the third concept, worth naming explicitly because it sounds like a standard of value and isn't. It's a contract term: the price or valuation mechanism the parties agreed to use between themselves. A buy-sell sets a contractual mechanism for a transfer, not necessarily the fair market value the IRS or a court will accept. If the provision is enforceable and applies to the dispute, it may bind the contracting parties, but it does not automatically bind the IRS, a non-signatory spouse, or a court applying a statutory valuation standard.
Conflating these three concepts can create drafting and litigation problems. A buy-sell drafted around one standard or contractual price can produce a different result when the same interest is examined under federal transfer-tax law, a state shareholder-remedy statute, or family law. Different numbers can therefore be legally consistent. By themselves, they don't show that the agreement was drafted incorrectly. For an owner reviewing the agreement, the practical question is whether its pricing mechanism will work under the rules likely to apply when the agreement is triggered.
When the Agreement's Price Can Control for Estate Tax
For federal estate, gift, and generation-skipping transfer tax, IRC §2703(a) generally requires specified rights or restrictions in a buy-sell agreement to be disregarded in valuing property, while §2703(b) provides the three-part test for its exception.
Two boundaries on that test matter. First, for closely held stock, the longstanding price-control requirements developed under Treas. Reg. §20.2031-2(h) and the case law operate alongside §2703. Satisfying §2703(b) therefore does not by itself guarantee that the agreement price controls estate-tax value. Second, §2703 applies only to a right or restriction created or substantially modified after October 8, 1990; an older arrangement that has not been substantially modified remains subject to the earlier rules.
Section 2703(a)'s disregard rule covers two categories: options, agreements, or rights to acquire property for less than fair market value, and restrictions on the right to sell or use property.
Revenue Ruling 59-60 makes a related point for closely held stock. Section 8 says the effect of a buy-sell agreement on estate-tax value depends on the circumstances: a binding agreement may or may not fix value, and an agreement that does not establish value is still one factor among the relevant valuation evidence. A stipulated value the parties agreed to years earlier may bind them contractually and still fail to control the IRS's transfer-tax valuation or a court applying a different state-law standard.
The Three §2703(b) Requirements
To avoid disregard under §2703(a), the right or restriction must satisfy three independent requirements set out in IRC §2703(b) and elaborated in Treas. Reg. §25.2703-1(b):
Bona fide business arrangement. The right or restriction must address a legitimate business purpose like succession, continuity, or restricting transfer to outsiders.
Not a device. The arrangement must not be a device to transfer property to members of the decedent's family for less than full and adequate consideration.
Comparable to arm's-length, measured at creation. At the time the right or restriction is created, its terms must be comparable to similar arrangements entered into by persons in an arm's-length transaction. The timing matters: comparability is judged against practice when the agreement was written, not at the triggering event.
Treas. Reg. §25.2703-1(b)(2) treats the three requirements separately. Satisfying one does not establish the others. For example, showing that a right or restriction is a bona fide business arrangement is not enough to establish that it is not a device.
The Exception for Businesses With Substantial Outside Ownership
Treas. Reg. §25.2703-1(b)(3) provides a deemed-met shortcut. All three §2703(b) requirements are deemed satisfied if more than 50 percent by value of the property subject to the right or restriction is owned, directly or indirectly (within the meaning of Treas. Reg. §25.2701-6), by individuals outside the transferor's family, and those owners' property is subject to the right or restriction to the same extent as the transferor's. For this rule, "family" also includes any individual who is a natural object of the transferor's bounty—roughly, someone the transferor would naturally be expected to benefit by gift or bequest. If either condition is not met, the arrangement must satisfy the three requirements directly.
Comparability: Measured Against the Market, Not the Family
Of the three requirements, comparability is the one that turns most directly on outside evidence. The question isn't whether the formula is internally coherent but whether it matches the market.
Treas. Reg. §25.2703-1(b)(4) frames comparability as a fair-bargain test. A right or restriction is comparable to arm's-length terms if it could have been obtained in a fair bargain among unrelated parties in the same business dealing with each other at arm's length. The regulation considers that standard met when the terms conform with the general practice of unrelated parties under negotiated agreements in the same business. The analysis generally considers the expected term of the agreement, the current fair market value of the property, anticipated changes in value during the term, and the adequacy of any consideration given.
The regulation does not require a formal market study. Comparability still looks outward to the general practice of unrelated parties in the same business, and a few isolated comparables are not enough to establish that practice. The regulation is also tolerant of method choice. Where more than one valuation method is commonly used in a business, using only one of the recognized methods does not by itself fail the general-practice test. Comparables from similar businesses may be used where the business is unique.
A stipulated formula that looks reasonable around a kitchen table (book value at year-end, capitalized earnings at a fixed multiple) can diverge sharply from that practice.
Because the agreements predated §2703, Estate of True v. Commissioner, 390 F.3d 1210 (10th Cir. 2004), applied the older price-control test in Treas. Reg. §20.2031-2(h). The court asked whether the agreement provided a determinable price, bound the parties during life and at death, was legally enforceable, and reflected bona fide business reasons rather than a testamentary substitute. The True agreements failed the last requirement. The court's criticism of the family's tax-book-value formula—no independent appraisals, negotiation, or revaluation mechanism—also remains relevant to §2703(b) comparability.
What Connelly v. United States (2024) Settled for Redemption-Funded Buy-Sells
In a redemption-funded buy-sell, the corporation may own life-insurance policies on the owners so that policy proceeds provide cash to redeem a deceased owner's shares. Connelly addressed how corporate-owned proceeds are treated in the federal estate-tax valuation of the deceased shareholder's stock.
In Connelly v. United States, 602 U.S. 257 (2024), a unanimous Court held that a corporation's contractual obligation to redeem a deceased shareholder's shares is not necessarily a liability that reduces the corporation's value for federal estate-tax purposes. For a redemption at fair market value, the Court reasoned that the corporation's value and the number of outstanding shares fall together, leaving the shareholders' economic interests unchanged. A hypothetical buyer therefore would not treat the fair-market-value redemption obligation by itself as reducing the value of the decedent's shares. Life-insurance proceeds payable to the corporation are an asset that increases its fair market value under IRC §2031.
The Court's qualifier is deliberate and worth keeping in mind. In a footnote it declined to hold that a redemption obligation can never decrease a corporation's value. The Court noted that a redemption obligation could require a corporation to liquidate operating assets and thereby reduce future earning capacity. What the Court rejected was the categorical claim that all redemption obligations reduce net value.
Connelly addresses the §2031 fair-market-value analysis for shares in a corporation holding redemption-funded life insurance. Section 2703 asks a different question: whether a right or restriction in the buy-sell agreement is disregarded for transfer-tax valuation. Satisfying §2703(b) therefore does not resolve every valuation issue, and Connelly can matter when the agreement price does not control or when the agreement itself uses fair market value.
Connelly rejected Blount's insurance-offset valuation rule but did not address Blount's separate holdings on substantial modification, lifetime binding effect, or §2703 comparability.
What This Means for Existing Structures
After Connelly, rewriting the agreement is only one practical question. The estate-tax valuation also depends on who owns the life-insurance policies because that ownership can determine whether policy proceeds are included in the corporation's value.
Two structures are especially useful to distinguish:
Corporate-owned policies funding a redemption. When the corporation is the policy beneficiary, the proceeds are an asset of the corporation for the estate-tax fair-market-value analysis. Under Connelly, a fair-market-value redemption obligation does not by itself offset those proceeds.
Cross-purchase structures. The surviving owners, rather than the corporation, own the policies and receive the proceeds used to purchase the deceased owner's shares. Because the proceeds aren't paid to the corporation, Connelly's corporate-valuation holding doesn't reach that fact pattern.
The decision settles the specific valuation issue it addressed; it does not dictate how owners fund transitions.
Practical Checks for a Buy-Sell Valuation Provision
A defensible buy-sell valuation provision generally identifies the intended standard of value and a workable mechanism for updating or determining price. It also makes clear whether the interest is controlling or minority and marketable or nonmarketable. The governing legal requirements depend on the forum and purpose. Arm's-length comparability is one part of the federal transfer-tax analysis, not a universal rule for every forum.
Several principles matter when reviewing or drafting a buy-sell provision:
Match the provision to the governing forum and purpose. If federal estate-tax treatment is a central objective, the provision should be evaluated against §2703, §2031, and the applicable price-control authorities. If a state-law shareholder remedy is the likely setting, the controlling state statute and case law determine the relevant valuation standard and whether the contractual provision controls.
Refresh stated values when the agreement requires it. Federal law does not impose an annual or biannual refresh rule. If the agreement itself requires periodic updating, however, Treas. Reg. §25.2703-1(c)(1) presumes that a failure to update is a substantial modification unless it can be shown that updating would not have resulted in one.
Use a determinable process, not just a stale number. A buy-sell can use an appraisal or other valuation mechanism, including a multi-appraiser process, instead of a permanently frozen dollar figure. That is a contractual choice, not a regulatory requirement. For closely held stock, the federal estate-tax price-control authorities still require the price to be fixed or determinable from the agreement and the arrangement to satisfy the other applicable requirements. When the agreement calls for an appraisal, the appraiser's professional standards are a separate question from §2703 comparability. If multiple valuation methods are commonly used in the business, using one recognized method does not by itself fail the regulation's general-practice test.
Whether a buy-sell provision holds up depends on more than having a tidy formula. The valuation standard and mechanism have to work in the forum where the provision is likely to be tested. A provision built for an IRS estate examination may be the wrong instrument for a state-court dissenters' action, and vice versa. Before the next triggering event, the practical question is whether the provision was drafted for the forum most likely to test it.
Frequently Asked Questions
Does my buy-sell agreement's stated price control for estate tax?
Not automatically. For a right or restriction created or substantially modified after October 8, 1990, §2703(b) requires three things—a bona fide business arrangement, no device to transfer property to family for less than full and adequate consideration, and arm's-length comparability at creation—or the right or restriction must qualify for the non-family deemed-met rule. For closely held stock, older price-control authorities also apply, including fixed-or-determinable pricing and lifetime/death binding requirements, among others. If the agreement price does not control, the interest is valued under the applicable federal fair-market-value rules.
What did the Supreme Court decide in Connelly v. United States?
In Connelly v. United States, 602 U.S. 257 (2024), the Court held that life-insurance proceeds payable to a corporation are included in the corporation's FMV. On the facts before it, the corporation's fair-market-value redemption obligation did not offset those proceeds. The Court expressly declined to hold that a redemption obligation can never reduce corporate value. The decision rejected the contrary life-insurance-offset rule used in Estate of Blount v. Commissioner (2005).
Do I need an independent appraisal for my buy-sell agreement?
Federal transfer-tax law does not categorically require an independent appraisal in every buy-sell agreement. For §2703 comparability, the question is whether the right or restriction could have been obtained in a fair bargain among unrelated parties and whether it conforms with general practice in the same business. An appraisal mechanism may be one way to determine price, but adding or changing that mechanism in an existing agreement can raise a separate substantial-modification issue under Treas. Reg. §25.2703-1(c).
Are cross-purchase and redemption buy-sells valued the same way?
After Connelly, corporate-owned proceeds funding a redemption are included in the corporation's FMV. In a cross-purchase, the surviving owners own the policies, so the proceeds aren't part of corporate value and Connelly's holding doesn't reach that fact pattern. The broader tax and legal trade-offs between the structures require separate analysis.
What standard of value applies in a shareholder, LLC, or partnership dispute?
State law and the governing entity and contract documents control. Corporate appraisal proceedings often use a state-law "fair value" standard, but oppression remedies, LLC or partnership disputes, and discount rules vary by jurisdiction and by remedy. The agreement's "agreed value" may be relevant or contractually binding if the provision is enforceable and applies to the dispute, but it does not automatically bind a court conducting an independent statutory valuation.
Is "fair market value" the same as the agreement's "agreed value"?
Not necessarily. Agreed value is the price or valuation mechanism the parties contracted to use; fair market value is the federal tax standard under §2031 and the related regulations, with Revenue Ruling 59-60 providing guidance for closely held stock.
About Redwood Valuation
Redwood Valuation provides business valuation for closely held companies, including gift and estate tax valuation involving buy-sell agreements. We also provide litigation support, including expert-witness work, in shareholder and divorce matters.
If you're evaluating a buy-sell valuation provision or facing a triggering event, we're happy to talk through the framework for your situation.