Supreme Court Decision Impacts Buy-Sell Agreements for Closely Held Companies

The recent Supreme Court decision in Connelly v. U.S. has significant implications for the structuring of buy-sell agreements for closely held companies and the use of Life insurance to fund such arrangements. The case involved the valuation of a deceased shareholder’s shares in a family business, Crown C Supply, based on the proceeds of a Life insurance policy taken out by the company.

In 2001, the Connelly brothers, Michael and Thomas, who were the sole shareholders in Crown C Supply, made an agreement that gave the surviving brother the right to buy the deceased brother’s shares. Crown purchased $3.5 million in Life insurance policies for each brother, with the intention of using the proceeds to repurchase the deceased brother’s shares. When Michael passed away in 2013, Crown received $3.5 million in Life insurance funds.

The IRS challenged the valuation of Michael’s estate, arguing that the $3 million in Life insurance proceeds should be included as an additional non-operating asset, significantly increasing the value of Crown shares. Thomas Connelly filed a suit against the IRS seeking a refund of over $1 million in estate tax, but the courts ruled in favor of the IRS.

The Supreme Court’s decision clarified that a corporation’s contractual obligation to redeem shares is not necessarily a liability that reduces the company’s value for estate tax purposes. This means that the proceeds from the Life insurance policy increased the fair market value of the company, as the cash received is considered an asset of the company.

Jay Judas of Life insurance Strategies Group noted that the parties could have avoided this issue by using a cross-purchase buy-sell arrangement, where shareholders purchase policies on each other to fund the repurchase of shares. However, this structure has its drawbacks, including tax consequences for the shareholders.

Business owners with buy-sell agreements in place should review their arrangements and funding mechanisms with their advisors to ensure they are structured appropriately. With potential changes to federal estate and gift tax exemption amounts on the horizon, it is crucial for owners to address any necessary adjustments proactively.

In conclusion, the Connelly decision serves as a reminder for business owners and advisors to stay informed about legal developments that could impact their arrangements and take proactive steps to mitigate potential issues.