How Will the SCOTUS Decision in Connelly Impact Closely Held Corporations
October 9, 2024In a landmark decision on June 6, 2024, the Supreme Court has affirmed the lower Court’s decision upholding the IRS position on how life insurance proceeds and redemption obligations should be treated for federal estate tax purposes. The case, Connelly, as Executor of the Estate of Connelly vs. United States, involved the valuation of a small, family-owned business. Two brothers were sole shareholders of Crown C Supply, a building supply corporation. They entered into a buy-sell agreement whereby the surviving brother would purchase the deceased brother’s shares. If the surviving brother declined, the corporation itself was required to redeem the shares using life insurance proceeds. When one of the brothers died, the surviving brother chose not to purchase the shares thereby triggering the corporation’s obligation to redeem the shares using the $3 million life insurance proceeds. The estate reported the shares’ value at $3 million. However, the IRS valued the shares at $5.3 million, that is the value of the company plus $3 million, arguing the life insurance proceeds should be included in the corporation’s valuation, thereby increasing the estate tax liability by almost $900,000.00.
The District Court and the Eighth Circuit upheld the IRS’s position and the Supreme Court affirmed, ruling that a corporation’s contractual obligation to redeem shares does not reduce the corporation’s value for estate tax purposes.
The most immediate and obvious consequence of the Connelly decision is the potential for substantially higher estate tax bills for business owners with insurance funded buy-sell agreements. By including the life insurance proceeds in the valuation of the business interest, the overall taxable estate may increase significantly. This could lead to liquidity issues for the estates that were not prepared for this additional tax burden. There will be an increase in the complexity of business valuations. Business appraisers must address this in determining the fair market value of businesses with insurance funded buy-sell agreements. The Connelly case represents a seismic shift in the business planning environment.
The Supreme Court’s decision creates 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 consulting with professionals to better manage their estates.
This advisory is a general overview of these changes and is not intended as legal advice. If you have any questions about this advisory, please feel free to contact Paul Ambrose at (201) 442-2730 or via email at PAmbrose@cullenllp.com.