In June 2024, the U.S. Supreme Court issued a unanimous decision in Connelly v. United States, a case with far-reaching consequences for business owners—especially those operating closely held corporations with life insurance-funded buy-sell agreements. The Court determined that life insurance proceeds received by a corporation to redeem a deceased shareholder’s shares must be included in the corporation’s fair market value for estate tax purposes. This ruling caught many by surprise, as it was widely assumed that such insurance proceeds would not factor into the corporation’s valuation.
Case Overview
The case centered on Crown C Supply, a family-run building supply business in St. Louis, Missouri, owned by brothers Michael and Thomas Connelly. The two had a buy-sell agreement stating that upon the death of one brother, the surviving brother could opt to purchase the deceased’s shares. If he declined, the corporation would be obligated to redeem the shares using proceeds from a life insurance policy. When Michael passed away in 2013, Thomas declined to purchase the shares, prompting the company to redeem them using $3 million from a life insurance payout.
The Legal Conflict
Michael’s estate reported the value of his shares as $3 million—the redemption price. However, the IRS argued that the $3 million in life insurance proceeds should be factored into the corporation’s overall value. This adjustment increased the valuation of Michael’s shares, resulting in nearly $900,000 in additional estate tax liability. The estate contended that the corporation’s redemption obligation should offset the value of the life insurance, thereby lowering the company’s worth.
The Supreme Court’s Reasoning and Decision
The Supreme Court ruled that a corporation’s obligation to redeem shares does not diminish its value for federal estate tax purposes. The Court explained that a redemption at fair market value does not alter any shareholder’s economic interest in the corporation. Accordingly, the corporation’s value remains unchanged before and after the transaction, aside from the shift in ownership. As a result, life insurance proceeds used for the redemption must be included in the company’s fair market value—upholding the IRS’s position.
Key Takeaways for Business Owners
This decision presents several important considerations for business owners:
- Higher Estate Tax Exposure: Including life insurance proceeds in the corporate valuation can significantly increase estate taxes for heirs, possibly creating liquidity issues.
- Review Buy-Sell Agreements: Business owners should revisit their buy-sell agreements, particularly those funded through corporate-owned life insurance, to fully understand the tax implications.
- Consider Alternative Structures: One option is to implement cross-purchase agreements, where individual shareholders hold life insurance on each other. This method can keep insurance proceeds outside the corporate valuation and help avoid additional estate tax burdens. For businesses with more than two shareholders, more complex arrangements may be required.
It’s also important to keep the estate tax exemption in mind. The federal (and Connecticut) estate tax exemption currently stands at $13.99 million per individual. With proper planning, a married couple can shield up to $27.98 million from estate taxes. However, under existing law, that exemption is scheduled to drop to approximately $7 million per person on January 1, 2026—though Congress may act to extend the higher exemption.
The Connelly ruling highlights the critical importance of proactive estate and succession planning. Business owners should work closely with legal and financial advisors to review existing structures and identify tax-efficient strategies. Doing so will help ensure smooth transitions, protect business continuity, and minimize unexpected tax consequences.