The Impact of SCOTUS Decision in Connelly v. United States on Buy-Sell and Estate Taxes

If you’re a business owner who’s ever set up a buy-sell agreement or taken out life insurance to help fund one, the recent U.S. Supreme Court decision in Connelly v. United States should give you pause. In a ruling that could carry serious tax implications, the Court held that life insurance proceeds paid to a company must be included in the company’s valuation for estate tax purposes—even if those proceeds are immediately used to buy out a deceased shareholder’s interest.

This isn’t just a technical shift. It’s a reminder that even well-meaning planning can backfire without the right structure. If your company owns life insurance on a partner or key shareholder, you may want to reevaluate your current setup—because your heirs could end up with a tax bill nearly as large as the payout itself.

Connelly v. United States: The Court’s Decision

Micheal and Thomas Connelly were joint shareholders in Crown C Supply in St. Louis, MO. Micheal owned 77.18% of Crown’s shares. The brothers agreed that the surviving brother would have the option to purchase the deceased brother’s shares, otherwise the corporation would be required to purchase the shares. To ensure the company was able to repurchase the shares, Crown took out a $3 million life insurance policy for each brother. Upon Micheal’s death, Thomas declined to purchase Micheal’s shares; therefore, the company was obligated to purchase the shares under the terms of the agreement.

Relying on the Eleventh Circuit’s decision in Estate of Blount v. Commissioner, 428 F. 3d 1338 (11th Cir. 2005), the accounting firm’s analyst excluded the $3 million in insurance proceeds that were used to purchase Micheal’s shares from the company’s valuation. The analyst believed, based on the Estate of Blount decision, that the company’s obligation to repurchase Micheal’s shares was a liability that offset the value of the insurance proceeds. Accordingly, the valuation of Crown C Supply was determined to be $3.86 million, and the value of Micheal’s shares were approximately worth $3 million.

By contrast, the IRS said that Crown’s obligation to purchase Micheal’s shares did not offset the value of the life insurance proceeds. Therefore, the $3 million was required to be added to the company’s valuation before determining the value of Micheal’s shares. Using the higher valuation, the IRS determined Micheal’s shares were worth approximately $5.3 million. Consequently, Micheal’s estate owed an additional $899,914 in estate taxes. The District Court and the Court of Appeals agreed with the IRS’s calculation, which was then appealed to the Supreme Court for review.

Upon review, the Supreme Court also agreed with the government. The Court held that the life insurance proceeds should be included in the valuation of a company, even if the total amount of proceeds are used to fulfill a contractual obligation to repurchase shares.

Impact for Businesses

The impact of the Court’s decision in Connelly is higher estate tax liability for business owners or key employees that are shareholders in a business. The current estate tax threshold for 2025 is $13,990,000 per individual. The value of the decedent’s estate above this threshold will be taxed at 40%. Businesses that have a key man policy will need to add the life insurance proceeds when determining the value of the business. Accordingly, the increased valuation will be used to determine the overall stock price and the value of the decedent’s shares when determining estate tax liability.

Given the Court’s ruling, it’s essential to carefully review all buy-sell agreements and their funding mechanisms. It is important to ensure these agreements are structured in a way that minimizes estate tax liability. Finally, alternatives that could be more tax-efficient include cross-purchase agreements or irrevocable life insurance trusts (ILITs) that would act as the owner of the policy rather than the corporation itself.

Cover photo by Mikhail Nilov via Pexels