With the estate tax threshold scheduled to be significantly reduced in 2025 when the Tax Cuts & Jobs Act sunsets, more business owners stand to be affected by a recent U.S. Supreme Court decision that may impact a corporation’s value for federal estate tax purposes.
In the case of Connelly v. United States, the U.S. Supreme Court ruled unanimously that the life insurance proceeds received by a corporation to fund a share redemption agreement increases the corporation’s value. However, the corporation’s contractual obligation to redeem such shares is not an offsetting liability.
This ruling upholds an Eighth Circuit decision favoring the IRS in a case involving two brothers, Michael and Thomas Connelly, and their small building supply company. When Michael, the majority shareholder, passed away, Thomas opted not to purchase Michael’s shares, making it necessary for the corporation to use the life insurance proceeds to buy back the shares. The Court stated,
The central question is whether the corporation’s obligation to redeem Michael’s shares was a liability that decreased the value of those shares. We conclude that it was not…
Nevertheless, the Court did acknowledge that a redemption could potentially reduce a corporation’s value if the redemption caused a liquidation of operating assets, which could ultimately reduce future cash flows.
Based on the Connelly ruling, business owners who have implemented entity-purchase agreements (as opposed to cross-purchase agreements, for example) could have a portion of the insurance proceeds increase a corporation’s value, thereby increasing their taxable estate. In light of the sunsetting of the current estate tax threshold coming in 2025, many business succession plans and buy-sell agreements will need to be revisited—and REDW can help.
