In a recent decision in Connelly v United States, the U.S. Supreme Court altered the calculation of estate tax on businesses that hold life insurance policies payable to shareholders. A business taking out a life insurance policy to redeem a deceased shareholder’s interest is a common strategy of closely held companies that can be utilized to keep a family-owned business within the family. A company holding a life insurance policy to transfer an owner’s business interest should review the purchase and redemption agreements to ensure that they are still an efficient tax structure.
Planning Ahead: Buy-Sell Agreements
A buy-sell agreement is a common method to provide a plan to transfer an owner’s business interest in the event of termination, retirement, divorce, disability, or death. Depending on how it is written, a buy-sell agreement can prevent the sale of equity interests outside of the ownership group, create a market for a shareholder’s stock, and fix the stock value for a closely held company—which has incredible value for estate tax purposes. The three primary forms of buy-sell agreements are (1) corporate redemption agreements; (2) cross-purchase agreements; and (3) hybrid agreements.
Estate Tax Valuation: Then and Now
Before 2024, some taxpayers took the position that the amount of life insurance proceeds received by a company that was specifically earmarked to redeem a deceased shareholder’s interest represented an asset (the life insurance proceeds) that was immediately offset by a liability (the payment in exchange for a shareholder’s interest) and was not includable in the valuation of the interest as part of the deceased shareholder’s estate for estate tax purposes.
In Connelly v. US, the U.S. Supreme Court held that where a closely held corporation holds a life insurance policy on a shareholder of the corporation, any proceeds of such policy used to purchase a deceased shareholder’s shares are includible in the valuation of the business for determining a deceased shareholder’s estate tax liability. In its decision, the Court turned the previous understanding of redemption agreements on its head.
Planning Ahead: Different Solutions
Redemption agreements distributing life insurance policies owned by the business should be immediately reviewed and reconsidered. Utilizing a cross-purchase agreement, a separate limited liability company to hold life insurance proceeds, split-dollar life insurance, or a trusted buy-sell agreement could provide a more favorable estate tax valuation for business succession consideration.
JAH Can Help
Our attorneys at JAH are here to help you plan and navigate the recent US Supreme Court decision in Connelly v United States ruling and how it will impact you. Click here to contact on of our attorneys if you require assistance.
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