Connelly v. United States: What the Ruling Means for Estate Taxes

Closely held businesses have long used company-owned life insurance policies to facilitate the repurchase of ownership interests of deceased owners. However, a recent Supreme Court ruling may have substantial succession planning and estate tax implications for those who employ this strategy.

On June 6, 2024, the Supreme Court ruled in Connelly v. U.S. (“Connelly”) that business owners should consider life insurance proceeds payable to the company for estate tax valuation purposes and ignore the mandatory redemption obligation under the buy/sell agreement.

Does the Connelly ruling change the tax law?

The Connelly ruling does not change the underlying tax code. However, it could alter valuation principles when a business uses company-owned life insurance to facilitate the redemption of a deceased owner’s ownership interest. Before Connelly, business owners and advisors relied on the ruling provided in Estate of Blount v. Commissioner (“Blount”). The Blount decision held that a contractual liability to use life insurance proceeds to purchase a decedent shareholder’s interest in a corporation would negate the need to include those insurance proceeds in the corporation’s valuation for estate tax purposes. The Connelly ruling represents a significant shift in how the Internal Revenue Service may view the valuation of closely held businesses that utilize life insurance strategies.

What does the Connelly ruling mean for business owners?

We recommend that business owners collaborate with their professional advisors to review existing buy-sell agreements and verify that they are structured with tax implications in mind. The structure of these agreements can significantly impact the business’s valuation for estate tax purposes.

Consider alternative buy/sell structures, such as cross-purchase agreements, when a limited number of owners exist to avoid the potential inclusion of life insurance benefits in the business’s valuation. This arrangement involves purchasing life insurance for each owner to facilitate the mandatory purchase upon an owner’s death.

Other strategies, including the use of irrevocable life insurance trusts or other funding mechanisms that do not rely as heavily on life insurance, should be considered to facilitate succession planning.

If you need assistance with your business’s succession plan, the Moore Colson Tax Practice Area can help. Our professionals can provide expert tax planning strategies for closely held businesses and their owners. Don’t hesitate to contact us for more information.