January 9th, 2025
Recent Supreme Court Ruling May Impact Your Business Succession Plan
Posted in: Business Law Tagged: Nidhi P. Patel
Author: Nidhi Patel
Taking a thoughtful approach to your business succession can reduce burdens for your loved ones. If your plan includes using a life insurance policy to fund a stock redemption agreement, the recent Supreme Court decision in Connelly v. United States (2024) may impact your business valuation and estate planning strategies.
The unanimous ruling clarified how life insurance proceeds used for stock redemption are factored into the valuation of a corporation for estate tax purposes, a decision that could increase the estate tax burden for closely held businesses. For business owners, this case serves as a critical reminder to evaluate how their buy-sell agreements and life insurance policies are structured to avoid unintended tax consequences. Here are the specifics of the case and why Connelly v. United States matters to you and your succession plan.
Michael and Thomas Connelly, co-owners of Crown C Supply, had a buy-sell agreement funded by $3.5 million life insurance policies to manage succession. When Michael passed away, the corporation redeemed his shares for $3 million using the insurance proceeds, a value reported on the estate’s tax return.
The IRS challenged this valuation, arguing that the insurance proceeds increased the corporation’s value. An independent appraisal excluded the proceeds, supporting the $3 million valuation. However, the IRS maintained that the proceeds should be included, resulting in a higher estate tax valuation.
Relying on a precedent set by the 11th Circuit in Estate of Blount v. Commissioner (2005), the estate argued that life insurance proceeds used for stock buyouts should not increase the corporation’s valuation for estate tax purposes. The reasoning was that these proceeds were offset by the obligation to pay them out during the stock redemption process, effectively neutralizing their impact on the corporation’s value.
The District Court granted summary judgment to the government of the United States, agreeing with the IRS that the $3 million in life-insurance proceeds must be included in the valuation of the corporation. The Eighth Circuit affirmed this decision. The Supreme Court affirmed the lower courts’ decisions, holding that the insurance proceeds increased the corporation’s value and, thus, the value of Michael’s shares for estate tax purposes.
The rationale was grounded in economic principles – the Supreme Court reasoned that a corporation’s redemption obligation had no effect on a shareholder’s economic interest and, as such, no hypothetical buyer of Michael’s shares would have treated the corporation’s redemption obligation as a factor that reduced the value of those shares.
This ruling has broad implications for succession planning in closely held businesses. Business owners are advised to thoroughly review and structure their succession planning strategies in a manner that would minimize the risk of a result similar to that in Connelly. To ensure your succession plan aligns with this ruling and avoids potential tax pitfalls, consult with a Stein Sperling business attorney today.
