Q: My partner and I use a life insurance-funded buy-sell agreement for our business. I saw a recent Supreme Court decision that discussed this very topic. How does that ruling affect estate tax planning and valuations for my business?
A: The Supreme Court’s ruling on June 6, 2024, in Connelly v. United States has significant implications for estate tax valuations concerning closely held businesses. The case centered on Michael and Thomas Connelly, co-owners of Crown C Supply, who structured a buy-sell agreement funded by life insurance. Following Michael’s death, the company received $3.5 million in insurance proceeds, which it used to redeem his shares. The IRS included these proceeds in Michael’s estate valuation, raising it from $3 million to $5.3 million. The Supreme Court affirmed this decision, emphasizing that life insurance proceeds, when designated for share redemption by the company, must be considered part of the estate’s value.
This ruling could raise estate tax liabilities for businesses using similar arrangements, potentially disrupting financial plans for heirs and business continuity. Business owners must reassess their estate planning strategies to mitigate these tax impacts, but the good news is that there are strategies available to do so. Here are some actions you may want to consider in light of the decision:
- Review Buy-Sell Agreements: Ensure agreements are structured to minimize estate tax liabilities by considering provisions that define how insurance proceeds will impact estate valuations. Regular reviews with legal and tax advisors are crucial to ensure compliance with current tax laws and to optimize tax efficiency based on evolving regulations.
- Consider Cross-Purchase Agreements: Explore alternative arrangements where surviving owners purchase deceased owners’ shares. This strategy not only avoids the direct inclusion of life insurance proceeds in estate valuations but also fosters continuity among owners, ensuring smoother transitions and preserving business operations.
- Utilize Irrevocable Life Insurance Trusts (ILITs): Implement ILITs to shield life insurance proceeds from taxable estates. Beyond tax benefits, ILITs provide robust asset protection by placing insurance policies beyond the reach of creditors, ensuring intended beneficiaries receive maximum benefits while minimizing estate tax burdens.
- Engage Professional Advisors: Seek specialized guidance from experienced tax and legal advisors who can develop tailored strategies in light of the Connelly ruling. Advisors can provide comprehensive reviews of existing estate plans, recommend adjustments to minimize tax exposure, and ensure compliance with complex legal requirements, thereby safeguarding the long-term financial interests of the business and its stakeholders.
In the wake of the Connelly ruling, business owners face heightened estate tax liabilities and the need for strategic estate planning. By reassessing and potentially restructuring buy-sell agreements, exploring alternatives like cross-purchase arrangements, and leveraging tools such as Irrevocable Life Insurance Trusts (ILITs), owners can proactively manage the financial impact of this precedent-setting decision. Collaboration with experienced legal and tax advisors is essential to navigating these complexities and aligning estate planning strategies with both business continuity and tax efficiency goals.
Know the Law is a bi-weekly column sponsored by McLane Middleton. Questions and ideas for future columns should be emailed to knowthelaw@mclane.com. Know the Law provides general legal information, not legal advice. We recommend that you consult a lawyer for guidance specific to your particular situation.