June 13, 2024
To Redeem or Not to Redeem – That Is the Question After Connelly
The Supreme Court recently rendered a much-anticipated decision in Connelly v. United States concerning closely held corporate-owned life insurance funding a redemption/entity buy-sell agreement.
In a unanimous decision, the Court ruled that life insurance proceeds received by a corporation to redeem shares of a deceased owner are not necessarily offset by the corporation’s corresponding obligation to purchase the interest, thereby increasing the value of the corporation. In other words, even though the business has a requirement and liability to purchase the deceased owner’s shares, the life insurance proceeds designated for that purpose are still considered to be an asset of the business. This results in an increase in the value of the business for the deceased shareholder’s estate. Historically, under prior case law, the death benefit has been offset by the corporation’s liability to buy out the deceased owner’s shares.
This ruling presents an opportunity to contact your business owner prospects and clients to discuss their buy-sell agreements.
Here are the key talking points:
- The decision applies to redemption/entity agreements funded with corporate-owned life insurance. It does not apply to cross purchase agreements.
- The decision primarily impacts business owners who have federal (or state) estate tax exposure because the life insurance death proceeds are included in the value of the business. This increases the value of each business owner’s interest upon death for estate tax purposes.
- Business owner clients who currently have redemption agreements funded with life insurance should review their agreement with their personal tax and legal advisors, including their estate planning attorney, to determine if the arrangement still meets their objectives.
- Depending upon the number of business owners, it may be beneficial to consider a cross-purchase agreement as an alternative. If there are multiple owners, a partnership, LLC, trusteed/escrow facilitated arrangement, or an owner-owned life insurance policy with an endorsement split-dollar arrangement, may be beneficial to reduce the number of policies to fund the buy-out.
- In exploring other buy-sell arrangements, clients should discuss any income tax considerations and the transfer-for-value rule with their personal tax and legal advisors before transferring any existing corporate-owned life insurance.
- If maintaining the redemption/entity arrangement is the appropriate decision and estate taxes are a concern, owners should review their estate plan to determine if their existing life insurance coverage is sufficient for estate liquidity purposes.
As a result of the Connelly decision, business owners should be encouraged to review the value of their business, any existing buy-sell agreement funded with life insurance, and their overall estate plan to help achieve their business, personal, and legacy goals.
- CONNELLY, AS EXECUTOR OF THE ESTATE OF CONNELLY v. UNITED STATES (2024). 23-146 Connelly v. United States (06/06/2024) (supremecourt.gov)
The companies of National Life Group® and their representatives do not offer tax or legal advice. Please encourage your clients to seek tax or legal advice from their appropriate professional advisor.
