A recent United States Supreme Court decision in the case of Connelly v. United States may affect how we use insurance policies in buy-sell agreements. Specifically, the case will impact the valuation of businesses that use a redemption buy-sell agreement. As a result of this ruling, insurance proceeds received by a company by reason of a redemption buy-sell agreement will result in an increase in the value of the business.
By way of background, the case involved two brothers, Michael and Thomas Connelly, who were the sole shareholders of a corporation. The corporation owned and was the beneficiary of a life insurance policy on each brother, so that if one brother died, the corporation could use the life insurance proceeds to redeem the deceased brother’s shares of stock. After Michael died, the Internal Revenue Service assessed taxes on his estate, including his stock interest in the corporation. The IRS determined that the corporation’s fair market value included the life insurance proceeds intended for stock redemption, and Michael’s estate sued for a tax refund. On appeal from the Eighth Circuit, the Supreme Court was asked to determine whether the life insurance proceeds were properly included in calculating the fair market value of the corporation for valuing the decedent’s shares for purposes of the federal estate tax. The circuit courts have been split on this issue, and so the Supreme Court stepped in to clarify the issue at hand.
In a unanimous opinion, the Supreme Court sided with the United States, holding 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 and that the value of the life insurance proceeds should be included for purposes of valuing the corporation. The Court held that, first, the contractual buy-back obligation does not impact the value of the company, as it does not economically impact any shareholder, and second, the life insurance proceeds are included in the value of the company for purposes of valuing the decedent’s shares, because this valuation must occur as of the date before the decedent’s death when the life insurance proceeds are still a company asset and not yet available to pay out to redeem the shares.
The practical result of this decision is that the insurance proceeds received by the corporation will increase the value of the business, possibly making redemption buy-sell agreements less appealing to many. If you have questions or wish to discuss if alternative succession plans may better align with your goals, call Schooley Law Firm today. This is likely to be an evolving area of law as the impacts of this decision play out and we are here to ensure our clients, friends, and advisors stay abreast of the situation.