Understanding the Impact of the Supreme Court Decision in Connelly v. United States on Business Planning and Estate Tax

On June 6^th, 2024, the United States Supreme Court upheld the 8^th Circuit Court of Appeals opinion in Connelly v. United States, a case involving the estate tax and the valuation of shares in a closely held corporation.  The ruling has significant implications for business owners with buy-sell agreements funded by life insurance, making it crucial to understand how this ruling impacts business owners’ estate planning and tax strategies. The Court ruled that life insurance proceeds used to fund the redemption of shares from a deceased shareholder must be included in the company’s fair market value when calculating the estate tax. This means that the proceeds increase the value of the decedent’s shares, thereby raising the estate tax liability.

Example:

A business is valued at $20 million and owns $10 million of life insurance on each of the two owners. If one owner passes away, the $10 million of insurance proceeds that the business receives on that owner’s life to repurchase their shares  are now, as a result of the ruling, included in valuing the business for the deceased owner’s estate valuation, potentially increasing the estate tax burden.

• Previously each owner’s shares would have been worth $10 million each, making the fair market value of business $20 million. As a result of the Connelly ruling, each owner’s shares are now worth $15 million; and the business’ fair market value for estate tax purposes is $30 million, as the $10 million of insurance must now be included.

What Does this Mean for Business & Tax Planning?

In light of the new ruling, it’s important for business owners to revisit all buy-sell agreements and their funding methods to ensure they are designed to minimize estate tax liabilities. For instance, considering alternative, more tax-efficient structures, such as transferring the policy to the other owner(s), a new LLC, or a new insurance trust. However, note that if the policies are permanent policies in a gain position, there may be a tax impact to transferring policies out of the entity.

Additional tax-efficient options that should be considered include transfers such as a 1035 exchange, an LLC capital contribution, or changing the policies to an employee benefit split dollar arrangement.

Regardless of the approach, business owners should explore alternative strategies to mitigate the resulting estate tax implications and consider the most tax-efficient methods for transferring or retaining existing life insurance policies. Adapting to these changes will be crucial for business owners seeking to optimize their estate planning and protect their assets for future generations.  Consulting with an estate planning attorney and a tax advisor, like Anchin, is strongly recommended to help navigate the complexities and execute any changes.

For more information on how the Connelly v. United States ruling may impact your estate and to explore alternative strategies for your business and estate planning, please reach out to your Anchin Relationship Partner.