Estate Planning and Buy-Sell Agreements After the Connelly Decision

In Connelly v. United States, the Supreme Court ruled that life insurance proceeds earmarked for share redemptions under a buy-sell agreement must be included in the fair market value of a business for estate tax purposes. This decision reverses the logic of earlier precedent and creates challenges for business owners who use company-owned life insurance to fund succession plans.

When shareholders in a closely held business plan for the inevitable, they often turn to buy-sell agreements funded by life insurance. The logic seems straightforward: if a shareholder dies, the insurance proceeds provide the liquidity needed to buy out their interest without crippling the business. For decades, estate planners relied on precedent suggesting these insurance proceeds would not inflate the company's value for estate tax purposes. The Supreme Court's June 2024 decision in Connelly v. United States upended that assumption.

The ruling creates immediate challenges for business owners who structured their succession plans around company-owned life insurance. More importantly, it emphasizes why the mechanics of your buy-sell agreement matter just as much as having one in the first place.

The Blount Foundation

To understand Connelly, we need to first revisit Estate of Blount v. Commissioner, a case from the Eleventh Circuit Court of Appeals. William Blount owned 83 percent of Blount Construction Company and had a buy-sell agreement that fixed his share value at $4.0 million. The company carried life insurance to fund the purchase.

After Blount's death in 1997, the IRS disputed the valuation, arguing the buy-sell agreement should be disregarded and that the $3.1 million in life insurance proceeds should be added dollar-for-dollar to the company's fair market value. The Tax Court agreed, valuing the company at $9.9 million.

The Eleventh Circuit reversed on a critical point. The court recognized that while the buy-sell agreement did not bind Blount during his lifetime (he controlled the company and could modify the agreement at will), the insurance proceeds were different from typical nonoperating assets. The court reasoned that because the insurance proceeds existed solely to fund a contractual obligation to purchase shares, they were offset dollar-for-dollar by that liability. You cannot count an asset without acknowledging the corresponding debt.

This logic provided comfort to estate planners for years. Company-owned life insurance seemed like a viable funding mechanism that would not create unintended estate tax consequences.

What Changed in Connelly

Michael and Thomas Connelly owned 77 percent and 23 percent, respectively, of Crown C Corporation, a building materials supplier. Their buy-sell agreement gave the surviving brother the right, but not the obligation, to purchase the deceased shareholder's shares. If he declined, the company was obligated to redeem them.

The agreement included a valuation mechanism: the brothers would meet annually with their accountant to establish a redemption price. If they failed to update the price for more than a year, the agreement called for the company to be appraised by a qualified appraiser.

When Michael died in 2013, the brothers had not updated the redemption price since a 2010 certificate of agreed value set it at $3.0 million. Rather than obtaining an appraisal as the agreement required, the estate and the company settled on a $3.0 million redemption price. Crown used $3.5 million in life insurance proceeds to fund the redemption and related expenses.

The IRS challenged this valuation, arguing the life insurance proceeds should be included in the company's value for estate tax purposes. The District Court was not persuaded by the Blount logic that treated insurance proceeds as offset by the redemption obligation. The court determined Crown's fair market value was $3.86 million immediately before Michael's death. Adding the $3.0 million in insurance proceeds brought the total to $6.86 million, making Michael's 77.18 percent interest worth approximately $5.3 million for estate tax purposes.

The Eighth Circuit affirmed, and the Supreme Court agreed. Writing for a unanimous court, Justice Thomas rejected the argument that the redemption obligation should offset the insurance proceeds. The Court held that because a redemption does not affect the fair market value of a company, the proceeds must be included when valuing the estate's interest.

Why This Matters for Your Business

The practical implications are significant. Consider three equal shareholders who each own one-third of a business worth $3.0 million. They purchase $1.0 million in life insurance on each shareholder to fund potential redemptions.

Under the Blount approach, if one shareholder dies, the insurance proceeds would flow through the company to redeem the shares at $1.0 million (one-third of the $3.0 million pre-death value), leaving the company with its original $3.0 million in assets and two remaining shareholders.

Under Connelly, when the shareholder dies, the company receives $1.0 million in proceeds, making it worth $4.0 million. The deceased shareholder's one-third interest is now worth $1.33 million for estate tax purposes. The company must produce this amount to redeem the shares, but after using the $1.0 million in insurance proceeds, it still needs an additional $333,000.

If the company's assets are tied up in equipment, inventory, or other operating necessities, finding that extra $333,000 could mean borrowing against assets at precisely the wrong time, selling critical equipment, or worse. This is the very scenario business owners try to avoid when they purchase life insurance in the first place.

Key Takeaways

•       Company-owned life insurance proceeds used to fund share redemptions now increase the company's fair market value for estate tax purposes, potentially creating a funding gap.

•       The Supreme Court rejected the Blount logic that these proceeds are offset by the redemption obligation, fundamentally changing how we calculate estate tax liability.

•       Cross-purchase arrangements, where shareholders purchase insurance on each other rather than having the company own the policies, may avoid this issue but create their own complications.

•       The most critical protection is ensuring your buy-sell agreement includes procedures for regular valuation updates and actually following those procedures.

•       Much of the dispute in Connelly arose because the brothers failed to follow the valuation procedures in their own agreement, highlighting that proper documentation without proper execution provides little protection.

Conclusion

The Supreme Court acknowledged that its decision creates challenges for business succession planning but emphasized that other structuring options exist. Cross-purchase arrangements were specifically mentioned as an alternative, though the Court also acknowledged their drawbacks.

The path forward for business owners is clear: have your succession documents reviewed to determine whether your buy-sell agreement's procedures result in a purchase price that controls for estate tax purposes. If they do, follow them religiously. The Connelly brothers might have avoided Tax Court entirely had they simply followed the annual valuation procedures specified in their agreement.

We cannot know what would have happened if they had updated their redemption price annually as required. We do know what happened when they did not, and the result was costly. Your business deserves better than hoping for a favorable outcome when the procedures are there to provide certainty.

Source: Willamette Management Associates Insights, April 2025