In the recent case of Connelly v. United States, the U.S. Supreme Court unanimously ruled that life insurance proceeds used to redeem stock owned by a deceased shareholder within a corporation should be included in the deceased’s estate when calculating the stock value. This case involved the valuation of a small, family-owned business and has significant implications for business owners nationwide. 

Case Overview

Michael and Thomas Connelly were brothers and sole shareholders of Crown C Supply Company (Crown), a building supply corporation. To secure the business's continuity within the family in case of either brother's death, a buy-sell agreement was established. This arrangement empowered the surviving brother to acquire the shares of the deceased brother. Alternatively, if the surviving brother opted not to purchase the shares, the corporation was obligated to purchase the shares. The share price would be determined either by a Certificate of Agreed Value executed annually by the parties' agreement or through two or more written appraisals. The agreement also authorized Crown to purchase life insurance on both brothers, where the proceeds of which could be used to effectuate the purchase transaction. 

After Michael's death, Thomas decided against buying his shares, obligating Crown to redeem them using $3 million of the $3.5 million life insurance payout. As executor of Michael’s estate, Thomas filed an estate tax return reporting the value of Michael’s company stock as $3 million, a valuation agreed upon by Thomas and Michael’s son, but not supported by a qualified appraisal. However, the IRS determined the entire $3.5 million of life insurance proceeds must be included in the value of Crown, despite Crown being obligated to use $3 million of those proceeds to redeem Michael’s shares. Therefore, the IRS determined the following:  

• The business’ value as of Michael’s date of death was $6.86 million. 
• Michael’s shares were worth $5 million. 
• The estate owed an additional $889,914 in estate tax. 

In a unanimous opinion, U.S. Supreme Court Justice Clarence Thomas held that the corporation's contractual obligation to use life insurance proceeds to redeem shares at fair market value was not a liability that reduced the value of shares, and thus, had to be included in valuation for purposes of federal estate tax. 

Impact to Business Owners

The Supreme Court's decision in this case highlights the critical importance of careful estate planning, selection of insurance products and the potential tax implications of corporate agreements. By proactively reviewing and structuring buy-sell agreements, evaluating life insurance policies and conducting a business valuation, business owners can better manage their estates, ensure smooth ownership transitions and minimize tax liabilities. Consider these few steps to ensure your estate is in order:  

• Review Buy-Sell Agreements – Evaluate the buy-sell agreements in place and ensure they are structured with tax implications in mind, as their structure can significantly affect estate tax liabilities.  
• Consider a Cross-Purchase Agreement – In a cross-purchase agreement, shareholders or trusts for the shareholder’s benefit, purchase insurance on each other. These can be structured to ensure insurance proceeds go directly to purchasing shares without inflating estate tax values.  
• Assess Life Insurance Policies – Analyze the impact of life insurance policies on your estate's valuation. Ensure policies are adequately valued and structured to avoid unexpected tax liabilities. 
• Seek a Certified Business Valuation – To ensure compliance with current market values and tax regulations, regularly obtain a certified business valuation to understand potential tax implications. Our experienced, credentialed pros can provide an accurate valuation, taking into account every factor impacting worth. Looking at the tangible and intangible assets, we deploy useful and objective analysis to guide informed decision making.  
• Consult Tax and Legal Advisors – Don’t do it alone. Work with estate planning attorneys and tax advisors to update your corporate agreements and structures, confirming they align with current laws and court rulings.  
• Plan for Future Tax Obligations – Develop financial strategies to cover potential tax liabilities arising from share redemptions or corporate obligations.  
• Document Agreements Thoroughly – Keep and maintain detailed records of all agreements, valuations and transactions to support your estate’s position in the case of disputes with the IRS.  

How We Can Help

The Connelly decision introduces uncertainty for closely held businesses using company-owned life insurance in buy-sell agreements for succession planning. In these cases, the solution may exacerbate problems rather than resolve them, particularly for businesses aiming for seamless continuity without jeopardizing cash flow. Redeeming shares with life insurance can become prohibitively costly for closely held businesses whose shareholders' estates exceed the estate tax exemption threshold. That’s where we come in. The pros at Doeren Mayhew stand ready to review your buy-sell agreements, conduct a certified business valuation and help plan for future tax liabilities. We have the credentialed expertise to set you on the right path forward.