If you own a private business and have a buy-sell agreement in place that’s funded with life insurance proceeds, the U.S. Supreme Court’s recent decision in Connelly v. U.S. (2024) may affect your estate planning and your estate tax bill.
In Connelly, The Court ruled that when a closely held company receives life insurance proceeds to buy back a deceased shareholder’s shares, those proceeds count toward the value of the business for estate tax purposes. That alone may not sound like much at first, but it can create significant and unexpected tax liability for families and estates depending on the size of the estate. Consider this, most businesses secure enough life insurance to cover the value of their business in the event of their death. So, if your business is worth $20,000,000 and you have life insurance on the owners to cover that amount – your business is now worth $40,000,000 according to the IRS. Double the value could mean double the estate tax in the event of your death.
So, what is a business owner to do? First you need to understand the case.
Understanding the Connelly Decision.
The Connelly case involved two brothers, Michael and Thomas Connelly, who were also co-owners of a family business located in St. Louis, Missouri. In an effort to make sure the company stays within the family, its buy-sell agreement required the company to buy out a deceased brother’s share, funded by company-owned life insurance policies. When Michael passed away, the company collected $3.5 million in life insurance and used $3 million to redeem his shares as outlined in the buy-sell agreement. Michael’s estate filed an estate tax return and valued Michael’s share in the company on its fair market value, excluding the life insurance proceeds.
The IRS disagreed with this exclusion and argued that the company’s value had increased by $3.5 million because it received the insurance proceeds, and as a result, Michael’s shares were worth more, and the estate should have paid more estate tax based on the higher value.
The Supreme Court sided with the IRS and ruled that Micheal’s estate must include the life insurance proceeds when determining the fair market value of the business for estate tax purposes and emphasized that a shareholder’s life insurance payout paid to the company was part of the business arrangement and therefore couldn’t be separated from the overall value of the ownership.
This ruling overturned the prior interpretation and common practice that generally allows life insurance proceeds to be excluded from business valuation, and has altered estate planning strategies for many owners of closely held businesses in the U.S.
Who Should Be Paying Attention?
The Connelly decision does not affect all businesses, but it could have real consequences for
- Owners of closely held businesses (e.g., family businesses, partnerships, and small corporations).
- Businesses use redemption-style buy-sell agreements (where the company, not the individual owners, buys the shares).
- Businesses that own life insurance policies on the owners to fund the redemption.
- Business owners with estates over the deferral estate tax exemption, which is currently $13.61 million (or $27.22 million for married couples) in 2024, but is set to drop by half in 2026 unless Congress acts.
If your estate is likely to be worth more than $7 million after 2026, and you are an owner of a closely held business that has a life insurance proceeds funded buy-sell arrangement, it’s time to act.
Potential Impacts on Business Succession Planning.
The most immediate and obvious impact of the Connelly decision is the potential for higher estate tax bills for closely held business owners with life insurance proceeds funded buy-sell agreements. The IRS can include the insurance proceeds as a part of the business valuation, even if those proceeds are earmarked for redemption. For example, suppose a company is worth $10 million and has two $5 million life insurance policies to redeem shares in the event of the death of one shareholder. In that case, the IRS may now value the company at $20 million for estate tax purposes.
As a result, businesses need to review or revise their buy-sell agreement or shareholder agreement. Agreements that were structured based on the assumption that insurance proceeds would be excluded from valuation may no longer be optimal for their intended goal.
With the potential for higher valuation and increased tax liability, trusts, succession plans, and estate tax planning strategies may now need to be reassessed. Business owners may need to consider shifting from redemption agreements to cross-purchase agreements, creating irrevocable life insurance trusts, utilizing a family limited partnership, or other alternative business succession strategies in order to achieve their intended business succession goals.
What You Should Consider Doing Now.
If your business has a buy-sell agreement funded by life insurance, now is the time to revisit it.
- Review your corporate governance documents to determine whether the company is required to buy shares from a deceased shareholder using life insurance proceeds.
- Coordinate with your business attorney and estate planner to evaluate whether your current structure still meets your business succession goals, and to explore alternative arrangements that could reduce the risk of your family facing an unexpected tax bill later.
- Educate your successors about the ruling and communicate with them about the financial and tax implications, prepare them for possible tax consequences, and ensure a smooth transition of ownership.
Should you have any questions about the Connelly decisions and their implications on your business and estate planning or would like to schedule a free initial consultation to discuss alternative business succession strategies or other business or estate planning related issues, contact Navigant Law Group, LLC at (847) 253-8800 or email us at hello@navigantlaw.com.
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