On June 6, 2024, the U.S. Supreme Court unanimously decided Connelly v. United States, a case with direct consequences for closely held companies that use corporate-owned life insurance to fund buy-sell agreements.

Background. Two brothers owned a building supply company. Their buy-sell agreement required the company to redeem a deceased brother’s shares, and the company held life insurance on each brother to fund that obligation. After one brother died, the company received $3.5 million of insurance proceeds and used $3 million of it to redeem his shares.

The holding. The estate argued that the company’s obligation to redeem the shares offset the insurance proceeds, so the proceeds added nothing to the company’s value. The Court disagreed. A redemption at fair market value does not reduce the value of each shareholder’s interest. It simply changes the number of shares outstanding. The insurance proceeds were therefore a corporate asset includible in the company’s value for estate tax purposes. The lower courts had also found that the agreement’s price did not control value for estate tax purposes, in part because the parties did not follow the agreement’s own pricing mechanism.

Implications for business owners:

• Review redemption agreements funded by entity-owned insurance. Under Connelly, the proceeds may increase the estate tax value of the deceased owner’s interest without a corresponding offset.
• Consider alternative structures. Cross-purchase agreements, in which owners hold policies on each other, or insurance held in a separate entity, may avoid including the proceeds in company value. Each structure carries its own tax, cost, and administrative trade-offs, so counsel should be involved.
• Specify the valuation mechanism. The agreement should define the standard of value, the level of value, the treatment of insurance proceeds, and the valuation date and process.
• Follow the agreement. A price set informally or a process that is not followed is unlikely to be respected by the IRS.

We assist owners and their counsel with buy-sell agreement reviews, periodic valuations under existing agreements, and date-of-death valuations of interests subject to these agreements.