On June 6, 2024, The U.S. Supreme Court, in a unanimous decision, held that life insurance proceeds received by a corporation to fund a shareholder redemption agreement increased the corporation’s value for estate tax purposes.
Since December 2023, estate planning professionals have been closely monitoring the Supreme Court’s June 6, 2024 decision in Connelly v. United States, a case which involved the Estate of Michael Connelly (the “Estate”), a share redemption (purchase) agreement he had with his brother, Thomas Connelly, and their building supply corporation, Crown Supply. The share redemption agreement stipulated that upon the death of the first-to-die brother, the surviving brother would have the option to purchase the deceased brother’s shares. If the surviving shareholder declined, Crown Supply would be required to purchase the shares. To ensure the availability of cash to fund the purchase of shares from the first-to-die brother’s estate, Crown Supply purchased a $3.5 million dollar life insurance policy on each of the two shareholders.
Upon Michael’s passing in October 2013, a valuation of Crown Supply was completed so that the Estate’s interest could be purchased. The $3 million valuation did not reflect the insurance proceeds that were received because Thomas and the Company took the position that the insurance proceeds were offset by a corresponding liability of the Company to purchase the shares. Thomas declined to purchase Michael’s shares individually and, per the agreement, Crown Supply purchased Michael’s shares for $3 million, using the proceeds of the life insurance policy.
When it came time to file Michael’s federal Estate tax return, the return listed the value of his shares in Crown Supply at $3 million. Subsequently, the Estate was audited; and the IRS took the position that Crown Supply’s redemption obligation did not offset the life insurance proceeds received by the company, contrary to the position taken by Thomas and Crown Supply.
By calculating the value of the Estate including the life insurance and multiplying that total by the Crown Supply ownership percentage held by Michael at the time of his death (77.18%), the IRS ruled the Estate owed $889,914 in additional taxes, which was then paid by the Estate but also resulted in Michael’s Estate suing the IRS, seeking a refund.
A district court and the Eighth Circuit Court upheld the IRS’s decision. The U.S. Supreme Court then agreed to hear the dispute. In issuing its opinion, the Supreme Court said that an obligation to redeem shares at fair market value does not offset the value of life insurance proceeds set aside for the redemption because a share redemption at fair market value does not affect any shareholder’s economic interest. The Court concluded no hypothetical purchaser of the shares of Michael’s Estate would have treated Crown Supply’s obligation to redeem those shares as a reduction to the share value.
The Supreme Court’s decision should cause owners of a closely held business to review the role of corporate-owned life insurance as part of its succession planning. If corporate-owned life insurance is being used, or is being considered, as part of a redemption or buy-sell agreement, then owners should work with their attorneys and accountants on alternative approaches to avoid the potential inclusion of the insurance proceeds in determining the value of company stock for redemption or buy-sell purposes. Absent proper planning, a decedent’s estate could now unexpectedly find itself in a taxable situation, potentially unwinding years of prior planning and causing challenges to executors and family members. In addition to the federal estate tax, there may also be related income tax considerations that can affect shareholders of these closely held companies.
If you would like more information, please reach out to any one of our Estate Planning or Business Valuation professionals below. Each can be reached at 716.633.1373. Andrew T. Moon, CPA/ABV, Tax Partner Specializing in Business Valuations
Alec J. Marotto, CPA/ABV, Accounting & Auditing Partner Specializing in Business Valuations
Adam P. Ohar, CPA/ABV, Tax Principal Specializing in Estate Planning and Business Valuations
Mark A. Tronconi, CPA, MBA, Tax Partner Specializing in Estate and Succession Planning
Thank you.
