UNDERSTANDING THE SUPREME COURT’S DECISION IN CONNELLY V. UNITED STATES: IMPLICATIONS FOR BUSINESS OWNERS

In June 2024, the U.S. Supreme Court delivered a unanimous decision in Connelly v. United States, a case that carries significant ramifications for business owners, particularly those with closely held corporations employing life insurance-funded buy-sell agreements. The Court ruled 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 when determining estate taxes. The decision was a surprise to many who had previously thought that the value of life insurance proceeds would not be included in a corporation’s fair market value.

Case Background

The case involved Crown C Supply, a family-owned building supply company in St. Louis, Missouri, owned by brothers Michael and Thomas Connelly. They had a buy-sell agreement stipulating that upon the death of one brother, the surviving brother could purchase the deceased’s shares; if declined, the corporation was obligated to redeem the shares using life insurance proceeds. After Michael’s death in 2013, Thomas chose not to purchase the shares, leading the corporation to redeem them using $3 million from life insurance proceeds. 

Legal Dispute

The estate reported the value of Michael’s shares as $3 million, corresponding to the redemption price. However, the IRS contended that the life insurance proceeds should be included in the corporation’s value, increasing the valuation of Michael’s shares and resulting in an increase in estate tax liability in the amount of nearly $900,000. The estate argued that the redemption obligation should offset the life insurance proceeds, thereby reducing the corporation’s value. 

Supreme Court’s Analysis & Decision

The Supreme Court held that a corporation’s contractual obligation to redeem shares does not reduce its value for federal estate tax purposes. The Court reasoned that a fair-market-value redemption does not affect any shareholder’s economic interest and the corporation’s value remains proportional to its assets before and after the redemption. Consequently, the life insurance proceeds used for the share redemption should be included in the corporation’s value, affirming the IRS’s position. 

Implications for Business Owners

This ruling has significant implications for business owners:

1. Increased Estate Tax Liability: Including life insurance proceeds in the corporation’s value can substantially raise the estate tax burden on heirs, potentially leading to liquidity challenges. 
2. Reevaluation of Buy-Sell Agreements: Business owners should reassess their buy-sell agreements, especially those funded by corporate-owned life insurance, to understand the potential tax consequences. 
3. Alternative Structuring: Consider cross-purchase agreements, where individual owners hold life insurance policies on each other. This structure can prevent life insurance proceeds from increasing the corporation’s value, thereby mitigating additional estate tax liabilities. With respect to companies with more than two owners, other more complex structuring solutions are available. 

It is important to note that the increase in the estate tax value of a company’s shares resulting from the Connelly decision may be irrelevant to the shareholders if they do not face potential estate tax exposure. The federal and Connecticut estate tax exemption amount is currently $13.99 million per person, meaning that a married couple, with proper planning, can shield up to $27.98 million from estate taxation. Under current law, the estate tax exemption will decrease to about $7 million per person as of January 1, 2026, but there is a reasonable chance that the U.S. Congress will extend the higher exemption beyond 2025.

In conclusion, the Connelly decision underscores the necessity for meticulous estate and succession planning. Business owners should consult with legal and financial advisors to evaluate existing agreements and explore strategies that align with this ruling, ensuring tax-efficient transitions and preserving business continuity. For more information, please contact John R. Bambrick (jbambrick@brodywilk.com) or another BW attorney.