On June 13, 2024, the Supreme Court delivered its decision in Connelly v. United States, a landmark case that has significant implications for business owners with entity redemption buy/sell agreements. This ruling has reshaped the landscape of estate tax calculations and necessitates careful consideration of alternative structures for buy/sell agreements and life insurance policy ownership. Below is an in-depth analysis of the Supreme Court's decision and its potential impact on business continuity and estate planning.

Case Overview and Holding

In Connelly v. United States, the Supreme Court addressed the issue of whether the amount received by a corporation from life insurance proceeds via a buy/sell agreement should be included in the business value for estate tax purposes. The Court held that a corporation's obligation to redeem a deceased shareholder's stock under a stock redemption plan does not offset any includable corporate-owned life insurance proceeds when calculating the value of the corporation for estate tax purposes. This decision underscores the importance of understanding how buy/sell agreements are structured and their implications for estate tax calculations.

Impact on Estate Tax Calculations

The ruling has profound implications for business owners with buy/sell agreements funded with life insurance through an entity redemption design. Specifically, it means that the proceeds from such agreements will now be considered part of the value of the corporation, potentially increasing the estate tax liability of the deceased shareholder. This change requires business owners to reassess their current agreements to ensure they are prepared for the potential financial impact.

Alternative Structures for Buy/Sell Agreements

Given the Supreme Court's decision, business owners should consider alternative structures for their buy/sell agreements to mitigate the potential increase in estate taxes. Some options include:

1. Cross-Purchase Agreements: Instead of the business entity purchasing the deceased owner's interest, the remaining owners purchase the interest directly. This structure can avoid the inclusion of the buy/sell agreement proceeds in the decedent's estate.
2. Insurance LLC and "cross endorsement" buy-sell: A cross endorsed insurance LLC buy-sell arrangement is a business succession strategy in which a separate LLC purchases life insurance policies on the lives of each owner, and the insured endorses a portion of the death benefit to the other owners. The endorsed portion of the death benefit serves as a source of funds with which to purchase the shares of a deceased owner.
3. Trust-Owned Life Insurance: Trust-owned life insurance (TOLI) can also be used as an alternative to corporate-owned life insurance in buy/sell agreements. TOLI allows for greater control over policy ownership and avoids the issue of including the proceeds in the decedent's estate.

Considerations for Business Continuity

In addition to potential implications for estate tax calculations, Connelly v. United States also highlights the importance of ensuring continuity within a business in the event of a shareholder's death. Buy/sell agreements are designed to provide a mechanism for the orderly transfer of ownership and decision-making power in case of an owner's death. It is crucial for business owners to review their buy/sell agreements regularly and make any necessary updates or adjustments to ensure they accurately reflect the current state of the business.

Navigating Through the New Ruling

To navigate the complexities introduced by the Supreme Court's decision, business owners should take proactive steps, including:

1. Consult Financial, Tax, and Legal Advisors: Engaging with professional advisors is critical to fully understand the impact of the ruling and explore tailored solutions. Advisors can provide insight into structuring buy/sell agreements and life insurance policies to align with the latest legal standards and minimize tax liabilities.
2. Re-Evaluate Existing Agreements: Business owners should review their current buy/sell agreements to ensure they are structured optimally in light of the new ruling. This may involve renegotiating terms or adopting new agreement types.
3. Implement Robust Business Continuity Plans: Developing comprehensive business continuity plans that account for the changes in estate tax treatment can help ensure seamless transitions and protect the long-term interests of the business.

Conclusion

The Supreme Court's decision in Connelly v. United States represents a pivotal moment for business owners with buy/sell agreements. By including the value of life insurance proceeds in the value of the corporation without reducing for the purchase/stock redemption obligation, the ruling potentially increases estate tax exposure to shareholders. Business owners are encouraged to consult with their financial, tax, and legal advisors to understand the full implications of this decision and to implement measures that will safeguard their estate planning strategies.

For further information and insights, refer to the U.S. Supreme Court's official website and consult with qualified professionals who can provide personalized guidance.

At Granite Harbor, we specialize in providing tailored advice on the strategic structuring of buy/sell agreements and life insurance policies to optimize estate planning. Our expertise focuses on aligning with your overall business continuity and financial objectives. Schedule a complimentary consultation to explore how our solutions can mitigate estate tax liabilities and ensure a seamless transition for your business.