Connelly Vs. IRS

Summary

Life insurance proceeds, owned by and payable to a company for a shareholder redemption, will be included in the fair market value of the shares for an estate tax valuation standpoint. Previously, accepted practice was to treat the life insurance and the redemption obligation as offsetting - so they were functionally excluded from the estate tax valuation. This is a major change.

Supreme Court’s Final Decision

The question of whether a corporation’s buy-back obligation for a deceased shareholder's stock reduces the value of those shares has been clarified by the Supreme Court. The resulting case, Connelly vs. Internal Revenue Service, resulted in a unanimous decision in favor of the IRS.?

The ruling seems simple enough:? A buy-back agreement itself doesn’t necessarily decrease a corporation's value for estate-tax purposes.? The Court’s reasoning emphasized, in a concise nine-page opinion, that the full value of the company’s assets, including life insurance proceeds designated for the redemption, should be considered when determining the value of the shares for estate-tax purposes.

Key Points

???? The Supreme Court ruled life insurance proceeds received by the corporation increases the fair market value of the business for estate-tax valuation purposes.

???? Entity purchase/share redemption agreements may fall out of favor in many cases.

???? The impact of existing redemption arrangements needs to be carefully evaluated.

Action steps:

1. Prompt review of existing redemption agreements.
2. Carefully balance competing interests of business and shareholders.
3. Consider other types of arrangements for future buy-sell planning.

Important Notes: The fair market value of the shares increase for estate-tax purposes.? This is not an income tax issue. Should business owners consider modifying their existing plan, they should be mindful of the transfer for value rule and the impact to their existing coverage.

Suggested Recommendations

• Carefully review and adhere to the buy-sell agreement terms.
• Ensure distinction between buyers and sellers. (in the supreme court case the surviving brother served both as executor of the estate and representative of the company in settling the agreement)
• Establish readily determinable sales price in the agreement.
• Seek experienced legal counsel for drafting buy-sell agreements consistent with the result in Connelly case.
• Consider alternatives to life insurance-funded entity-owned redemption agreements. This likely also impacts LLC -redemption agreements, but does NOT impact cross-purchase arrangements. (Alternatives may include cross purchase agreements, endorsements buy-sell agreements or vehicles like separate trusteed cross purchase agreements.
• Factor in the importance of disability planning and business overhead insurance to protect the owners, in case a shareholder becomes disabled.

Your company’s buy-sell agreement may be impacted by this recent Supreme Court ruling or you provide advice to your clients in structuring buy-sell agreements.

LC Advisor works with business owners and their tax and legal advisors in designing and funding these programs. After the Supreme Court Ruling there is a call to action to review buy-sell agreements.?

?Contact Bob Flood at LC Advisor at 215-840-9816 or [email protected]