On June 6, 2024, the United States Supreme Court issued its ruling in Connelly v. United States. Connelly concerned the estate tax valuation of a corporation that was the owner and beneficiary of a life-insurance policy on one of its deceased shareholders. The policy proceeds received by the corporation were used to fund the redemption of the deceased shareholder’s stock. The Connelly Court ruled the value of the life insurance policy proceeds must be included in valuation of the deceased shareholder’s stock in the corporation (and thus included in value of the decedent’s estate) for purposes of calculating the estate tax without a corresponding offset for the stock redemption obligation. This is a significant ruling that will require closely held businesses to reevaluate the structure of buy-sell arrangements and corporate/entity-owned life insurance.
In Connelly, two sibling shareholders entered into an agreement under which, at either brother's death, the company would redeem the deceased brother’s shares using proceeds of the corporate-owned life insurance policy on the deceased shareholder. When the majority owner died in 2013, the company received the insurance proceeds and funded the redemption of his shares using the policy proceeds. The value of the shares disclosed on the estate tax return was calculated excluding the death benefit, reasoning that those amounts were offset by the company’s redemption obligation. The IRS challenged this value and succeeded on the theory that the company’s fair market value should have included the proceeds used to purchase the shares and without offset from the redemption obligation. The Court ruled 9-0 in favor of the IRS.
Takeaways
Following Connelly, owners of closely held businesses should reevaluate the structure of buy-sell agreements, life insurance policy ownership, and beneficiary designations. Corporate/entity-owned life insurance coverage may need to be increased to account for the increased value of the company that would include insurance proceeds. Alternatively, companies may wish to consider restructuring existing life insurance policy ownership and beneficiary designations to avoid the consequences in the Connelly case.
One such alternative which was specifically endorsed by the Court in Connelly is a cross-purchase agreement between a company’s owners. In the agreement contemplated by the Court, each of a company’s owners—rather than the company itself—would purchase a life insurance policy on the other owner’s life and use the benefits to purchase the deceased owner’s shares. However, there are income tax considerations that may affect transfer of existing life insurance policies so careful analysis is needed. We would be happy to discuss alternatives and possible restructuring with you.
If your company holds life insurance on the life of any of its owners for purposes of redeeming their ownership interest at death, you should consult an advisor promptly to consider the consequences of Connelly and determine whether any changes should be made.
YES! PLEASE SIGN ME UP TO RECEIVE EMAIL ALERTS FROM OTHER GUNSTER PRACTICE AREAS.
This publication is for general information only. It is not legal advice, and legal counsel should be contacted before any action is taken that might be influenced by this publication.
About Gunster
Gunster, Florida’s law firm for business, provides full-service legal counsel to leading organizations and individuals from its 13 offices statewide. Established in 1925, the firm has expanded, diversified and evolved, but always with a singular focus: Florida and its clients’ stake in it. A magnet for business-savvy attorneys who embrace collaboration for the greatest advantage of clients, Gunster’s growth has not been at the expense of personalized service but because of it. The firm serves clients from its offices in Boca Raton, Fort Lauderdale, Jacksonville, Miami, Naples, Orlando, Palm Beach, Stuart, Tallahassee, Tampa Bayshore, Tampa Downtown, Vero Beach, and its headquarters in West Palm Beach. With more than 280 attorneys and consultants, and over 290 committed support staff, Gunster is ranked among the National Law Journal’s list of the 500 largest law firms and has been recognized as one of the Top 100 Diverse Law Firms by Law360. More information about its practice areas, offices and insider’s view newsletters is available at www.gunster.com
