The case of Connelly v. United States was decided by the Supreme Court on June 6, 2024.  The case concerned the valuation of a business for estate tax purposes.  Crown C Supply Co. was a business co-owned by two brothers, Michael and Thomas Connelly.  When Michael Connelly died, the company collected on a life insurance policy and was obligated to redeem Michael’s ownership in the company from his estate.

The IRS argued that the $3 million of life insurance collected by the company should be factored into the valuation of the company resulting in much higher estate tax owed by Michael’s estate.  The estate had argued that the life insurance proceeds should be offset by the $3 million obligation to redeem Michael’s stock.  In a unanimous decision, the Supreme Court sided with the IRS because a fair-market-value redemption has no effect on any shareholder’s interest.  The obligation to redeem shares is not a liability that reduces the value of the company for estate tax purposes.

Many businesses obtain life insurance to cover the cost of redeeming a shareholder upon death as part of a company buy-sell agreement.  The insurance proceeds are tax-free, and provide the company with funds to redeem the shares of the former owner.  When estate taxes are a concern for the business owner, owning insurance inside the company could result in additional estate tax.  While the current federal estate tax exemption is $13.61 million per person, that amount is scheduled to be cut in half starting in 2026.  The Minnesota estate tax exemption is only $3 million per person.

There are alternatives to companies directly owning life insurance on the life of their owners.  If there are only two owners, a cross-purchase arrangement can work, where each owner has a life insurance policy on the other owner.  If there are more than two owners of a business, a cross-purchase arrangement likely will not work.  Instead, a separate limited liability company (LLC) taxed as a partnership can be used to own the life insurance policies.  If the LLC is properly structured, it can serve the purpose of funding the redemption of shares of a deceased owner while avoiding the potential estate tax trap of company-owned policies.