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Estate Planning Implications of the Supreme Court Decision on Using Life Insurance to Fund Buy-Sell Agreements

June 20, 2024 - By: Richard P. Breed, III and Michael J. Radin

The recent decision of the Supreme Court of the United States has significant implications for everyone who relies on life insurance to fund buy-sell agreements, a commonly used strategy for owners of closely held businesses. The Court's June 6, 2024 ruling in Thomas A. Connelly, as Executor of the Estate of Michael P. Connelly, Sr., Petitioner v. United States, highlights the urgency of individuals covered by buy-sell agreements and the companies that use them carefully reviewing and structuring these agreements to minimize potential estate tax liabilities for a deceased owner’s estate and the companies’ own financial obligations.

Key Takeaways from the Decision:

1. Valuation of Life Insurance Proceeds Received by the Business:
  • The Supreme Court held that life insurance proceeds used to redeem shares of a deceased owner’s shares in a corporation should be included in the company's value for estate tax purposes. Those life insurance proceeds increase the fair market value of the company in the deceased owner’s estate.
  • The Court determined that the corporation’s contractual obligation to redeem shares owned by the deceased owner is not a liability offsetting the value added by the insurance proceeds.
  • Thus, there is an adverse ripple effect when the life insurance is held this way and a major planning opportunity lost.
2. Impact on Buy-Sell Agreements:
  • The decision emphasizes the need for careful structuring of buy-sell agreements between business owners to avoid unintended estate tax liabilities. Companies involved may need to proactively review the structures in place to adjust for this new decision.
  • Life insurance proceeds used in these agreements can significantly increase the estate’s value, thus increasing the estate tax. In the Connelly case, the Estate owed additional estate taxes of nearly $900,000.
3. Valuation Timing:
  • The decision reiterates the fundamental estate tax rule that the valuation point for determining estate taxes is the time of the shareholder's death, not after the redemption of the deceased shareholder’s shares.
  • From a corporate financing perspective, the decision shows a need to examine the impact of how life insurance proceeds would flow for financial statement and bank covenant purposes on a shareholder death and subsequent share purchase.
Background of the Case

Brothers Michael and Thomas Connelly were the sole shareholders in Crown C Supply, a small building supply corporation. Michael owned 77.18% (385.9 shares) and Thomas owned 22.82% (114.1 shares). The brothers entered into an agreement with Crown to ensure a smooth transition of ownership and keep Crown in the family if either brother died. The agreement gave the surviving brother the option to purchase the deceased brother's shares. If the surviving brother declined, Crown itself would be required to redeem (i.e., purchase) the shares. To fund the possible redemption, Crown obtained and was the owner and beneficiary of $3.5 million in life insurance on each brother. Importantly - and fatally for good tax planning - there was no so-called “cross purchase” arrangement where the shareholders (through a trust) owned and were the beneficiaries of the insurance policies.

When Michael died in 2013, Thomas opted not to purchase his shares, triggering Crown's obligation to redeem them. Michael's son and Thomas agreed the shares were worth $3 million, which Crown paid to Michael's estate using the life insurance proceeds. Thomas, as executor of Michael's estate, filed a federal estate tax return valuing the shares at $3 million.

The IRS audited the return. During the audit, an outside accounting firm valued Crown at $3.86 million, excluding the $3 million insurance proceeds used for the redemption, concluding those proceeds, although clearly an asset of Crown, were offset by Crown’s contractual obligation to redeem Michael’s shares. Since Michael owned 77.18%, the firm calculated his shares were worth about $3 million ($3.86M x 77.18%).

The IRS disagreed, counting the $3M proceeds and valuing Crown at $6.86M total, making Michael's shares worth $5.3M ($6.86M x 77.18%). This increased the estate tax by $889,914.

The estate paid the additional estate tax and sued IRS for a refund. The federal District Court and Eighth Circuit of Appeals ruled for the IRS, finding the insurance proceeds must be counted in Crown's valuation.

Supreme Court's Decision

The key issue before the Supreme Court was whether the life insurance proceeds used to redeem Michael's shares should be included when valuing those shares for estate tax purposes. The Court unanimously held that a corporation's obligation to redeem shares is not necessarily a liability that reduces the company's value for estate tax calculations.

The Court explained that life insurance payable to a company increases its fair market value. The question was whether Crown's contractual obligation to redeem Michael's shares at fair market value was a liability offsetting the insurance proceeds used for that redemption.

The Court said no - a fair-market-value redemption does not affect any shareholder's economic interest. No hypothetical buyer of Michael's shares (under the established “willing buyer-willing seller” analysis) would have considered Crown's redemption obligation as reducing the shares' value. When Michael died, Crown was worth $6.86M - the $3M insurance proceeds plus $3.86M in other assets. Anyone buying Michael's 77.18% stake would pay up to $5.3M ($6.86M x 77.18%), the amount they'd expect Crown to pay when redeeming the shares at fair market value.

The Court also rejected Thomas' arguments that a buyer couldn't capture the full $3M proceeds since they'd quickly leave Crown to redeem the Michael’s shares. The Court said the key valuation point for estate taxes is the shares' value when Michael died, before the $3M redemption, without the redemption obligation being an offsetting liability. To so hold, according to the Court, would contradict basic stock redemption mechanics. While redeeming shares reduces a company's value, the other shareholders’ economic interests in the corporation are increased pro rata following the redemption, in the Court’s view.

While this ruling may make succession planning for business owners harder by requiring more insurance to redeem shares at fair value, the Court said this is simply a consequence of how the brothers structured their agreement. That is, the brothers could have structured their agreement as a cross-purchase instead of a redemption, thereby keeping the insurance proceeds outside of Crown.

Estate Planning Impact & Strategies

This decision has major ramifications for estate planning with life insurance funded buy-sell agreements. The Court has made clear that insurance proceeds used to fund a buy-sell agreement and owned by the entity (instead of the business owners) will be included in the deceased owner's estate if the insurance death benefit increases the company's value. Companies and their attorneys must carefully review and possibly restructure existing buy-sell agreements to ensure they do not inadvertently increase estate taxes based on the Connelly rationale and could have the effect of increasing company valuations without providing any net value to the company itself. This includes exploring more flexible or hybrid arrangements that can provide tax advantages and liquidity without increasing estate tax or complicating company financial reporting or operating burdens.

Professional business appraisers and accountants also need to refine their valuation techniques to account for the impact of this decision. Business owners and company CFO’s should look at this now with their advisors and make adjustments to avoid the adverse tax consequences resulting from this decision.

Alternative Strategies to Consider include:
  • Cross-purchase agreements in which individual owners, not the company, own life insurance on each other. This structure prevents insurance proceeds from being considered part of the company’s value, thus avoiding the result in Connelly. This is a common structure.
  • Irrevocable life insurance trusts (ILITs). An ILIT can own life insurance policies, keeping proceeds out of the deceased owner’s estate, thereby reducing taxable value and providing liquidity for the deceased owner’s estate. Proper setup and management of these trusts are crucial to ensure compliance and effectiveness. This is also quite common.
  • Partnerships (and other entities taxed as partnerships and many LLCs are) may reduce the number of policies required for a cross-purchase agreement for a corporation with multiple shareholders. This is a technical issue so consult your tax and estate planning advisors.
For owners of private companies, careful estate planning is essential, especially when using life insurance to fund buy-sell agreements. Business owners with their advisors must be vigilant in structuring these agreements to minimize tax liabilities to better achieve their succession and financial planning objectives and not create an unintended impact on the company’s own finances resulting from the death of an owner.

For additional information please contact Rick Breed ( or Michael Radin ( of Tarlow Breed Hart & Rodgers, P.C., Boston.

This article is provided for informational purposes only and does not constitute legal advice. The information contained herein should not be relied upon or used as a substitute for consultation with legal, accounting, tax, or other professional advisors. Readers should contact an attorney licensed in their jurisdiction for advice on specific legal issues.

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