In Connelly vs. United States, the Supreme Court (SCOTUS) ruled that life insurance proceeds increased the value of a closely held business’ stock and therefore had to be included in valuation of the company for estate tax purposes. The ruling impacts some buy-sell agreements where the life insurance is owned by the company rather than by the individuals who own the company.
The case involved two brothers who owned unequal shares in their closely held business. The business bought life insurance, the proceeds of which were contractually required to be used to buy out the other brother should one brother die. SCOTUS ruled that the contractual obligation to use the life insurance death benefit to buy out the surviving brother did not eliminate the policy’s proceeds impact on increasing the value of the business (and therefore triggering increased estate tax liability).
Per the facts in the case, when one brother died, the estate valued the life insurance proceeds at $3.86 million, the amount paid for the policy. SCOTUS agreed with the lower courts that found that instead, the proper valuation was $6.86 million, the amount by which the company’s value increased as a result of payment of the death benefit. Part of the court’s reasoning derived from the unequal shares owned by the two brothers—one (the deceased brother) owned 77 percent of the company, the other (the surviving brother) owned 23 percent of the company.
Prospects The case raises the potential for needing to review buy-sell agreements as compared to cross-purchase agreements, and policy ownership (the result would have been different had each brother owned a policy on the other brother’s life rather than the company owning the policy). There are tax implications regardless of the form a buy-sell agreement takes, and so this case suggests that NAIFA members with clients who have buy-sell agreements should review those clients’ situations to be sure that the specific tax planning chosen by the client best fits the clients’ succession as well as tax planning.
NAIFA Staff Contact: Jayne Fitzgerald – Director – Government Relations, at jfitzgerald@naifa.org.