|
Recent Supreme Court Decision Impacts Estate Planning for Closely Held Corporation
A landmark case for businesses was decided by the Supreme Court on June 6th, 2024, unanimously upholding the inclusion of life insurance proceeds used to fund a buy-sell agreement, as an asset when calculating estate taxes.
The case, Connelly v. United States, arose over a buy-sell agreement implemented by two brothers as the lone shareholders of their family business. To prevent outside ownership, following the death of either brother, they agreed that only the remaining shareholder would have the option to purchase the shares of the deceased. However, if the shareholder declined the corporation would redeem the shares in question. To ensure this was properly funded the corporation took out a $3.5 million life insurance policy on each brother.
Following the passing of Michael Connelly his brother, Thomas, was presented the option to purchase his shares totaling 77.18% of the company. Thomas declined to do so, instead choosing for the corporation to uphold its obligation to redeem the shares. At the time of Michael’s death, Thomas assessed the value of the company to be $3.86 million, therefore paying 3 million dollars for the shares from the life insurance policy. After the completion of this transaction Thomas, as executor, filed an estate tax return with the IRS for the estate of his deceased brother. The IRS selected this return to be audited, and completed their own valuation concluding that the corporation should include the $3 million in life insurance as an asset resulting in a higher valuation. This increased the value of the shares held by Michael to $5.3 million for estate tax purposes, resulting in additional taxes owed of $889,914.
After paying this overage Thomas filed for a refund arguing that the obligation to redeem Michael’s shares offsets the value of the life insurance proceeds. The District Court disagreed granting summary judgment to the government and ruling that the life insurance proceeds should be included in the value of the company. The US Court of Appeals for the Eighth Circuit affirmed this ruling creating a circuit split. A prior case in the Eleventh Circuit, Estate of Blount v. Commissioner, ruled that life insurance proceeds created an offset liability when they were incurred out of a redemption obligation.
The issue before the Supreme Court was whether the value of life insurance proceeds is offset by the obligation to buy back shares when those proceeds are committed to funding the redemption. The Court held that the obligation to redeem shares is not a liability and should not reduce the value of a corporation when levying federal estate taxes. Additionally, the Court found that to properly value a corporation the proceeds from a life insurance policy intended to be used in the redemption of stock should be included when calculating the fair market value of the corporation.
The Court articulates that there are alternatives to the type of planning used in this case. An example of such is a cross-purchase agreement. This alternative removes the corporation from the stock agreement, and instead requires the shareholders to purchase life insurance policies on each other. This moves the life insurance benefit and burden to the stockholders individually. However, this method grows increasingly complicated in companies with more than two shareholders, or where there are significant age or health differences between the shareholders.
This case highlights the importance of proper planning regarding estate taxes. This ruling will impact closely held entities using life insurance policies to fund buy-sell agreements by reclassifying the insurance proceeds as an asset of the business, thus increasing the value of the business by the value of the life insurance and increasing the size of the business owner’s estate for estate tax purposes. Businesses with company owned insurance need to revisit their buy-sell agreements.
| 
