Supreme Court Connelly Decision and Buy-Sell Agreements

In Connelly v. United States, decided June 6, 2024, the Supreme Court held unanimously that life insurance a company owns to fund a buyout counts toward the company's value for federal estate tax, and that the company's promise to redeem the shares does not cancel it out. For owners whose estates may face federal estate tax, that is a real reason to look again at an entity redemption buy-sell agreement.

What the Supreme Court Decided in Connelly

Two brothers owned Crown C Supply. Their agreement said the company would buy back the shares of whichever brother died first, and the company owned a policy on each of them to pay for it. When Michael Connelly died, the company received $3.5 million in life insurance proceeds and used $3 million of it to redeem his shares.

The estate reported the shares at about $3 million. The IRS valued the company at $6.86 million, which put Michael's shares near $5.3 million. The family received $3 million and owed estate tax on roughly $5.3 million. The additional tax in the case was $889,914.

The estate argued that the company's duty to redeem the shares was a liability that cancelled the insurance. The Court disagreed. According to the opinion, the obligation to redeem did not reduce the value of the shares, so the proceeds counted as an asset. Justice Thomas gave a simple picture: if a company holds only cash, buying out one owner at fair value leaves the other owner's position about the same. Treating the buyout as a debt would make the survivor's shares worth more, which makes little sense.

Why the Entity Redemption Agreement Took the Hit

For years, many advisors assumed the insurance and the buyout obligation netted to roughly zero. That assumption sat inside thousands of entity redemption agreements, where the company owns the policies and is the beneficiary. Connelly broke it.

A cross purchase design works differently. Each owner holds a policy on the others, so the proceeds go to the surviving owner and not to the company. The Court itself noted that the brothers could have used a cross purchase arrangement, and also noted that it has its own drawbacks, including the risk that an owner stops paying premiums and different tax results. Our comparison of cross purchase and entity redemption walks through those trade-offs.

Two points keep this in proportion:

• It mainly affects taxable estates. The extra value only costs the family something when the estate is large enough to owe federal estate tax. The IRS explains the filing rules on its estate tax page, and the threshold has changed several times over the years.
• The agreement in the case was weak. It never set a determinable price, and the annual certificates of agreed value it called for were never completed. Better paperwork may have changed the story, though no one can promise that.

The Court also noted in a footnote that a redemption obligation can sometimes lower a company's value, for example when it forces the company to give up operating assets. The ruling rejected the idea that every redemption obligation does so. It did not close every door.

What This Means for Your Buy-Sell Agreement

The ruling applied immediately, with no transition period. The Court wrote about corporations, and cautious planners assume the same thinking could reach LLCs and partnerships. Your attorney can tell you how it applies to your entity.

Designs Owners Are Looking At

• Cross purchase. Policies sit outside the company. Works best with a small number of owners, because the policy count grows fast: seven owners would need 42 policies.
• Insurance LLC. A separate entity, usually taxed as a partnership, holds one policy per owner. It aims to give cross purchase results without a policy web.
• Entity redemption, with care. It may still fit where no estate tax is expected, but state estate taxes, the price formula, and future rule changes all deserve a look.
• Extra death benefit. Some owners with a redemption they cannot avoid add coverage to help with the potential tax, subject to underwriting.

Key Person Coverage Is a Separate Question

The case turned on whether a buy-sell obligation offsets the value of insurance proceeds. Coverage the company owns to replace a key employee, with no buyout attached, does not raise that question in the same way. Our guide to key person insurance covers how that coverage works. Employer-owned policies still need written notice and consent before they are issued, and the company files IRS Form 8925 each year.

A Short Review List for Owners

1. Who owns each policy, and who is the beneficiary?
2. Does the agreement set a price or a method, and was it updated recently? See how to value a business for a buy-sell agreement.
3. Is the buyout an obligation or only an option?
4. Would your estate owe federal or state estate tax today?
5. Is the coverage still the right size? Our buy-sell review checklist goes through each step.

Moving policies between owners or into a new entity can trigger other tax rules, so ask counsel before you change anything. Your attorney drafts the agreement and your CPA confirms the tax treatment. Cornerstone designs and places the insurance that funds it. More on buy-sell agreement funding is on the blog.

Talk It Through Before the Next Anniversary

If your agreement was signed before 2024 and the company owns the policies, it is worth a fresh look this year. Our business owners strategy hub shows how the pieces fit together, and you can schedule a conversation with Scott whenever you are ready.