by Chris SwiecickiThe 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
by Chris SwiecickiSpecial Update: Supreme Court Ruling on Chevron
The Supreme Court’s 6-3 ruling on Friday, June 28th 2024, effectively overturned a 1984 decision colloquially known as “Chevron.” This 40-year precedent directed courts to defer to a federal agency’s interpretation of laws passed by Congress that are ambiguous, so long as the agency’s interpretation is reasonable.
What is the Chevron Doctrine?
Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc. is a landmark Supreme Court decision that centered on the Environmental Protection Agency’s (EPA) interpretation of the Clean Air Act Amendments of 1977. In a 6-0 unanimous decision, the Supreme Court held that when a statute is ambiguous, courts should defer to the reasonable interpretation of the administrative agency charged with implementing the statute. This principle became known as the “Chevron deference.” Although at the time it was not considered as a particularly substantial decision, this ruling eventually became one of the most important decisions in federal administrative law and provided future administrations wide power to issue stronger environmental rules. Chevron has been the basis for upholding thousands of federal regulations in the 40 years since the Supreme Court made their landmark decision.
The Court’s Decision
Two related cases, Loper Bright Enterprises v. Raimondo and Relentless v. Chamber of Commerce, were initiated by herring fishermen challenging a federal regulation issued by the National Marine Fisheries Service. The agency’s policy required them to pay $700 per day to carry federal monitors on their vessels.
These cases raised a broader question: Whether the Supreme Court should overturn the 1984 Chevron decision. In a 6-3 decision, the Supreme Court overturned the Chevron decision and ruled that courts no longer need to defer to federal agencies’ interpretation of the laws.
In the opinion, Chief Justice John Roberts said courts “must exercise their independent judgment in deciding whether an agency has acted within its statutory authority.” The court’s holding was based on the determination that the Chevron doctrine was inconsistent with the Administrative Procedure Act, which provides the procedures for federal agencies to follow.
The Administrative Procedure Act states that courts should interpret statutes, which directly contradict the Chevron decision. Chief Justice Roberts indicated that the decision to overrule Chevron would not require earlier cases relying on Chevron doctrine to be overturned; however, going forward it is likely to have far-reaching effects across the federal government by allowing courts to interpret federal regulations without deferring to federal agencies.
Impact
Overturning the 40-year precedent greatly reduces the regulatory power of government agencies. This decision effectively shifts authority away from the executive branch and Congress, giving more power to the courts in interpreting laws and regulations. On one side, supporters of the Chevron deference argue that this grants the courts too much power and creates an imbalance of powers. The Biden administration has defended the Chevron decision and feared overturning it could destabilize the legal system. However, on the other hand, many people argue that the Chevron doctrine allowed the executive branch too much power and that the overturning will lead to a balancing of power.
The Supreme Court’s decision is anticipated to have significant effects on federal regulations across various areas. Federal regulations have a great influence on the food we consume, transportation methods, housing, and the world around us. With the Chevron doctrine overturned, those who oppose regulations now have a more straightforward path to contest them. Regulatory agencies will likely exercise greater caution when formulating rules, making sure the intent of the rule is clear. In addition, regulations based on unclear or ambiguous language in statutes may face increased difficulty in enforcement. Overall, it is expected that this decision will likely trigger a flood of litigation against federal agencies and may impede the regulatory process.
Featured images by Phung Touch via Pexels.