On June 6, 2024, the Supreme Court issued a unanimous decision in Connelly v. United States, significantly affecting how business owners and families approach estate tax planning. The ruling addressed whether life insurance proceeds used to redeem shares in a closely held corporation could reduce the corporation’s taxable value for estate tax purposes. The Court held that such proceeds cannot be offset by the corporation’s obligation to redeem shares, a decision with far-reaching implications for business succession planning and estate taxes.
For many families and business owners, the Connelly ruling underscores the importance of understanding how buy-sell agreements, life insurance, and corporate obligations influence estate valuations. At Estate Planning Pros, we help connect families and business owners with an estate tax planning lawyer to create strategies that align with both legal requirements and individual goals.
The Core Issue In Connelly V. United States
The case revolved around Crown C. Supply, Inc., a closely held business owned by brothers Michael and Thomas Connelly. They had a buy-sell agreement requiring the company to redeem a deceased brother’s shares using life insurance proceeds. After Michael’s death, Crown used $3 million from a life insurance policy to redeem his shares, and the estate reported Crown’s value at $3.86 million, excluding the $3 million in proceeds as an offsetting liability.
The IRS disagreed, asserting that the life insurance proceeds should be included in Crown’s valuation, increasing the company’s value to $6.86 million. The Supreme Court upheld the IRS’s position, ruling that the redemption obligation did not offset the proceeds for estate tax purposes. This decision highlights the Court’s view that life insurance proceeds tied to stock redemptions do not diminish the value of the corporation in the eyes of a hypothetical buyer or seller.
Implications For Business Owners
The Connelly decision presents important considerations for business owners using life insurance to fund buy-sell agreements. Life insurance proceeds are now unequivocally included in the valuation of a closely held corporation for estate tax purposes, even if those proceeds are tied to a redemption obligation.
This ruling means that buy-sell agreements, a common tool for business succession, must be carefully structured to avoid unintended tax consequences. Agreements that rely on life insurance proceeds for stock redemptions must comply with specific conditions under Section 2703(b) of the Internal Revenue Code if they are to influence the corporation’s valuation. Otherwise, the agreement will be disregarded for estate tax purposes, potentially inflating the taxable value of the estate.
For example, in Connelly, the buy-sell agreement did not meet the criteria under Section 2703(b), which requires that the agreement be a bona fide business arrangement, not a device to transfer wealth to family members at less than fair market value, and comparable to arm’s-length transactions.
Broader Estate Planning Considerations
The Supreme Court’s ruling may have the greatest impact on estate tax planning if the federal estate tax exemption is reduced from $13.61 million to approximately $7 million per individual in 2026. This reduction will likely bring more estates into the taxable range, especially for business owners whose companies include non-operating assets like life insurance.
Business owners should evaluate how the inclusion of life insurance proceeds affects their estate’s taxable value. This may involve restructuring buy-sell agreements to meet Section 2703(b) requirements or adopting alternative planning strategies, such as creating irrevocable life insurance trusts (ILITs) to hold and manage life insurance policies outside of the estate.
Additionally, the Connelly ruling highlights the importance of accurate valuations and compliance with IRS regulations. Estates that undervalue corporate assets risk audits, penalties, and significant tax assessments, as seen in this case.
Why This Matters For Families And Business Owners
The Connelly decision emphasizes the need for careful planning when structuring buy-sell agreements and life insurance policies within estate plans. For families who want to preserve wealth and minimize tax burdens, these details can make a substantial difference in how much of the estate passes to heirs versus being lost to taxes.
For example, if a family-owned business is heavily reliant on life insurance proceeds to fund redemptions, the failure to account for those proceeds in the estate valuation could lead to a larger-than-expected tax bill. Addressing these issues early can help business owners avoid disputes and unexpected liabilities.
Take Action To Protect Your Legacy
The Supreme Court’s decision in Connelly v. United States reinforces the importance of proactive and precise estate tax planning. Whether you’re managing a closely held business, structuring a buy-sell agreement, or assessing the impact of life insurance on your estate, this case highlights the need for well-informed strategies that comply with legal standards.
At Estate Planning Pros, we connect families and business owners with an estate tax planning lawyer to create personalized plans that protect assets and align with your goals. Don’t leave your legacy to chance—contact us today to find the right attorney for your needs and take the first step in securing your family’s financial future.