Supreme Court Rules in Connelly Case

On June 6, 2024, the U.S. Supreme Court ruled in Connelly, As Executor of the Estate of Connelly v. United States, affirming the ruling of the Eighth Circuit. See 602 U.S. ___ (2024). In short, the Court held that “a corporation’s contractual obligation to redeem shares is not necessarily a liability that reduces a corporation’s value for purposes of the federal estate tax.”[1] How does this ruling affect estate planning, estate taxes, and businesses?

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Summary of Connelly

In this case, Michael and Thomas Connelly were brothers and sole shareholders in their company, Crown C Supply (“Crown”). The corporation had an agreement that, when one of the brothers died, Crown would use the proceeds of corporate-owned life insurance to redeem the shares of the deceased brother. When Michael died, Thomas filed a federal estate tax return on Michael’s behalf and valued the estate’s shares of Crown at $3 million (excluding the life insurance proceeds from the company valuation).[2]

After the IRS audited the estate, the IRS issued a notice of deficiency – concluding that the $3 million in life insurance proceeds should have been included as an asset of Crown, increasing the value of Crown shares significantly. The IRS valued the estate’s shares of Crown at $5.3 million (versus Thomas’ valuation of $3 million).[3]

Thomas sued the IRS for a tax refund on behalf of Michael’s estate. The U.S. District Court for the Eastern District of Missouri ruled in favor of the IRS, and the Eighth Circuit Court of Appeals affirmed the decision. The case went to the U.S. Supreme Court, which ruled unanimously in affirming the Eight Circuit’s ruling. The Court ruled that the corporation’s obligation to redeem shares is not a liability that reduces the corporation’s value for federal estate tax purposes, and that the fair market value of the company included the life insurance proceeds designated for the stock redemption.[4]

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How Connelly Affects Estate Taxes

Because of the ruling in Connelly, entity-purchase agreements may not always be the most beneficial for your business. The Court noted in its opinion that the parties in this case could have avoided the increase to the fair market value of the company by having across-purchase buy-sell agreement instead.[5] In a cross-purchase buy-sell agreement, the shareholders (rather than the corporation) take out policies on each shareholder and use those proceeds to buy out the deceased shareholder. This type of buy-sell agreement has its potential disadvantages: each shareholder pays the insurance premiums, and each shareholder may face tax consequences. However, this type of buy-sell agreement can avoid the issue that the Connelly brothers faced.  If you are the owner of a closely held business with a buy-sell agreement, reach out to a tax professional to review your agreements and for advisement on any changes that you should make.

If you would like more information on Business Succession Planning and buy-sell agreements, check out Business Succession Planning.

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Conclusion

Business succession planning is an important part of the estate planning process. Complying with current law is crucial when forming your estate plan. Having the best plan in place for you and your business will ensure a smooth transition with a goal to minimize federal tax liabilities. An estate planning attorney can answer your questions and help you set up a plan for you and your business.

Contact Montgomery Legal today to discuss your case and legal options. Schedule a Consultation or call (214) 432-6100.

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[1] Connelly v. Internal Revenue Service, Ballotpedia, available at https://ballotpedia.org/Connelly_v._Internal_Revenue_Service.

[2] Id.

[3] Id.

[4] Id.

[5] Susan Rupe, Supreme Court’s Connelly Decision Could Impact Buy-Sell Agreements, InsuranceNewsNet (June 2024), available at https://insurancenewsnet.com/innarticle/supreme-courts-connelly-decision-could-impact-buy-sell-agreements.