Supreme Court Upholds Connelly: What It Means For Business Owners

In 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 v. United States[1], (602 US _____) involved the valuation of a small, family-owned business and has significant implications for business owners nationwide.

Case Overview

Michael and Thomas Connelly were the sole shareholders of Crown C Supply, a building supply corporation. To ensure the business stayed in the family if either brother passed away, they entered into a buy-sell agreement. This agreement allowed the surviving brother to buy the deceased brother’s shares. If the surviving brother declined, the corporation itself was required to redeem the shares using life insurance proceeds.

When Michael died, Thomas chose not to purchase the shares, triggering Crown’s obligation to redeem them 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, resulting in an additional estate tax liability of $889,914.

The District Court and the Eighth Circuit upheld the IRS’s view. 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.

Impact on Business Owners

This decision underscores the importance of strategic estate planning for business owners. Here are key actions to consider:

1. Review Buy-Sell Agreements

– Ensure your buy-sell agreements are structured with tax implications in mind. The structure of these agreements can significantly affect estate tax liabilities.

2. Consider Cross-Purchase Agreements

– A cross-purchase agreement, where shareholders, or trusts for the shareholder’s benefit, purchase insurance on each other, can avoid complications by ensuring insurance proceeds go directly to purchasing shares without inflating estate tax values.

3. Evaluate 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.

4. Seek Professional Valuation

– Regularly obtain professional valuations to understand potential tax impacts and ensure compliance with current market values and tax regulations.

5. Consult Tax and Legal Experts

– Work with estate planning attorneys and tax advisors to review and update your corporate agreements and structures, ensuring they align with current laws and court rulings.

6. Plan for Future Tax Obligations

– Set aside funds or develop financial strategies to cover potential tax liabilities arising from share redemptions or corporate obligations.

7. Document Agreements Thoroughly

– Maintain detailed records of all agreements, valuations, and transactions to support your estate’s position in case of disputes with the IRS.

Conclusion

The Supreme Court’s decision in Connelly v. United States 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 consulting with professionals, business owners can better manage their estates, ensure smooth ownership transitions, and minimize tax liabilities.

[1] 23-146_i42j.pdf (supremecourt.gov)