Written by: William Cooper, CPA
On June 6, 2024, the Supreme Court issued a ruling in Connelly v. United States that has significant implications for privately held business owners. The Court unanimously decided that the value of company-owned life insurance policies must be included in the estate valuation for federal estate tax purposes, regardless of any contractual obligations that dictate how these insurance proceeds are used.
The main takeaway: This decision marks a pivotal moment in estate planning for business owners who rely on life insurance as part of their business succession strategies. The decision underscores the need for business owners to carefully evaluate how their life insurance policies and redemption agreements are structured.
The Core of the Connelly Decision
The Connelly case addressed whether the death benefit from a company-owned life insurance policy should be included in a closely held business’s valuation for estate tax purposes. The Supreme Court clarified that the full value of these proceeds must be included in the estate valuation, regardless of whether the proceeds are used to redeem a deceased shareholder’s shares.
Implications for Business Owners
This ruling has profound implications for business owners with company-owned life insurance policies. The Court effectively raises the potential estate tax liability for business owners and their heirs by mandating that life insurance proceeds be included in the estate’s valuation. The decision underscores the need for business owners to carefully evaluate how their life insurance policies and redemption agreements are structured.
Consider the following key points:
- Increased Estate Tax Liability: Including life insurance proceeds in the estate valuation could significantly increase the estate’s taxable value. For some business owners, this could mean a substantial portion of the intended benefits for their heirs is instead paid as estate taxes. In the Connelly case, for example, the estate’s valuation increased by $3 million due to the inclusion of life insurance proceeds, doubling the estate tax liability from $1.19 million to $2.12 million.
- Review of Redemption Agreements: Business owners should review their existing redemption agreements, particularly those that rely on company-owned life insurance. The ruling suggests that simply using life insurance proceeds to buy out a deceased shareholder’s interest will not shield those proceeds from being included in the estate’s valuation. Owners may need to consider alternative arrangements or modifications to existing agreements to mitigate the impact of this ruling.
- Impact on Business Succession Planning: For closely held businesses, succession planning often involves life insurance as a tool to ensure a smooth transition of ownership. The Connelly ruling introduces new complexities into these plans, making it essential for business owners to revisit their strategies. Tax advisors can help explore options such as changing the structure of life insurance policies or altering ownership arrangements to reduce estate tax exposure.
What Steps Should Business Owners Take?
In light of the Connelly decision, business owners should take the following steps to protect their interests and those of their heirs:
- Consult with Tax and Legal Advisors: The complexity of estate tax laws means that professional advice is crucial. Tax and legal advisors can help assess the impact of the ruling on your specific situation and recommend changes to your life insurance and estate planning strategies.
- Review and Possibly Restructure Agreements: If your business has redemption agreements funded by company-owned life insurance, it is essential to review these agreements immediately. Consider whether changes are needed to avoid unexpected estate tax liabilities.
- Understand the Transfer-for-Value Rule: Before making any changes to life insurance policies, be aware of the transfer-for-value rule. This rule stipulates that if a life insurance policy is transferred to another party for something of value, a significant portion of the death benefit may become taxable as ordinary income. This potential tax consequence should be carefully weighed when considering changes to policy ownership.
Final Thoughts
The Supreme Court’s ruling in Connelly v. United States serves as a critical reminder for business owners to stay vigilant in their estate and succession planning. The inclusion of company-owned life insurance proceeds in estate valuations adds a new layer of complexity that could have significant financial implications. By taking proactive steps, business owners can better manage their estate tax exposure and ensure that their plans continue to align with their long-term goals.
This ruling highlights the importance of regular reviews of estate planning strategies, especially for those involving closely held businesses. As always, the guidance of experienced tax and legal professionals will be invaluable in navigating these challenges and safeguarding your legacy.
If you have questions about how the Connelly decision may affect your business or need assistance with estate planning, our team of advisors is here to help. Contact us today to schedule a consultation.