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The Supreme Court rules that a company’s life insurance proceeds used to redeem a decedent’s stock must be included in the federal estate tax calculation

June 6, 2024

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Connelly v. United StatesNo. 23-146 – Decided on June 6, 2024

Today, the Supreme Court unanimously ruled that the proceeds of a life insurance policy taken out by a corporation to redeem the stock of a deceased shareholder are a corporate asset for federal estate tax purposes.

“An obligation to repurchase shares at fair market value does not offset the value of life insurance proceeds set aside for redemption because a redemption of shares at fair market value does not affect a shareholder’s economic interests.”

Judge Thomas, writing for the Court

Background:

Michael and Thomas Connelly were the sole shareholders of a closely held construction company valued at just under $4 million. The brothers entered into an agreement that required the company to repurchase the shares of the first brother who died if the surviving brother refused to buy them. The company then took out a life insurance policy for each brother to finance the share buyback. This is a common practice in family businesses to prevent a deceased person’s heirs from selling shares to outsiders.

When Michael Connelly died, the company used the life insurance proceeds to buy back his stock for $3 million. Michael’s estate did not treat the life insurance proceeds as a net business asset because those proceeds were allegedly offset by a corresponding obligation to purchase Michael’s stock, and therefore it paid estate taxes based on the company’s previous valuation of just under $4 million. The IRS concluded that the $3 million in life insurance proceeds were not offset by the company’s obligation to repurchase Michael’s stock, leaving the company worth just under $7 million. The IRS sent a notice of deficiency to the estate, which paid the deficiency under protest.

The district court granted summary judgment for the IRS and the Eighth Circuit affirmed, holding that the life insurance proceeds were a net asset that increased the value of the business.

Problem:

Are the proceeds of a life insurance policy taken out by a corporation on a shareholder to redeem the shareholder’s shares a corporate asset when calculating the value of a deceased shareholder’s shares for federal estate tax purposes?

Court:

Yes. Life insurance proceeds are an asset that increases a company’s fair market value, and a repayment obligation is not necessarily a liability that offsets that asset.

What it means:

  • Today’s decision focuses on the economic substance of the underlying transaction and explains that “(b) because a redemption at fair market value has no effect on the economic interests of a shareholder, no willing purchaser who would acquire Michael’s shares purchase, (the company’s) obligation to purchase Michael’s shares would have treated repurchasing Michael’s shares at fair market value as a factor that reduced the value of those shares.”
  • The decision confirms that the IRS may tax life insurance proceeds as business assets, even if those proceeds will ultimately be used to repurchase the outstanding shares of a deceased shareholder. Companies and estate planners should carefully review succession plans, including shareholder life insurance provisions and buy-sell agreements, with today’s decision in mind.
  • Today’s decision imposes potentially substantial costs on a common practice among closely held companies to ensure that ownership remains within a family upon the death of a shareholder. The Court acknowledged that its decision “will make succession planning more difficult for closely held companies.” The Court also identified ‘other options’, such as cross-purchase agreements, that are still available to achieve the same purposes as the instrument used here, but recognized that these options themselves carry disadvantages.
  • The Court emphasized the narrowness of its decision and specifically noted that it “did not consider that a repayment obligation can never decrease the value of a company,” and gave the example of a redemption obligation that “requires a company to liquidate corporate assets to pay for its stock, thereby reducing its future earning capacity.”

Gibson Dunn represented the Chamber of Commerce of the United States of America and the National Federation of Independent Business Small Business Legal Center, Inc., as Amici supports the petitioner.


The Court’s judgment can be found here.

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