As a business owner, you've likely set up a buy-sell agreement to ensure a seamless transition for your company in the event of an owner's departure. However, the recent Supreme Court ruling in Connelly v. U.S. has changed how life insurance proceeds are valued for estate tax purposes, which could significantly affect your estate and succession planning. With year-end approaching, this is an ideal time to review your agreement, allowing you to address potential tax impacts before tax deadlines and set up a solid foundation for the coming year.

Let’s dive into what’s changed, why it matters, and how to ensure your buy-sell agreement is structured to safeguard your business and legacy.

What the Connelly Decision Means for Business Owners

The Connelly decision centers on a crucial question: Should life insurance proceeds used to fund a buy-sell agreement increase the value of a deceased owner’s estate? Here’s what the Court ruled and why it’s critical for businesses:

• In Connelly, the Supreme Court ruled that life insurance proceeds received by a business to fund a buy-sell agreement must be included in the company’s value for federal estate tax purposes. This means your estate may face higher taxes if a business-owned policy is used in a buy-sell agreement.
• If your agreement is structured as an entity purchase, where the company buys the shares from the estate, the life insurance proceeds are treated as a corporate asset, potentially raising the company’s value and the deceased owner’s taxable estate. However, with a cross-purchase agreement, where each owner buys insurance on the other, the proceeds may avoid estate tax inclusion.

Key Considerations for Your Buy-Sell Agreement After Connelly

The Supreme Court’s ruling highlights the importance of carefully structuring buy-sell agreements. Here are some essential points to consider as you review your agreement:

1. Agreement Type Matters
   • Entity Purchase: The business purchases a departing owner's shares. Under Connelly, life insurance proceeds in these agreements may be subject to estate taxes.
   • Cross-Purchase: Each owner holds life insurance policies on the others and buys out the deceased’s shares personally. This arrangement might shield proceeds from estate tax, although it becomes complex with multiple owners.
2. Potential Tax Implications
   For businesses using an entity purchase agreement, the inclusion of life insurance proceeds in the estate’s valuation could increase tax exposure. This may leave less money for heirs or for the buyout itself, disrupting the intended succession plan.
3. Need for Flexibility in Agreement Terms
   Your buy-sell agreement should be adaptable, especially if you expect changes in estate tax laws. Options like installment payments, adjustable valuations or partial cross-purchase agreements can provide flexibility.
4. Alternatives to Consider
   • Cross-Endorsement or Split-Dollar Agreements: In these structures, life insurance policies can be strategically endorsed or partially owned to minimize estate tax impacts.
   • Policies Owned in Insurance LLC: This approach uses a separate LLC to own and manage the life insurance policies funding the buy/sell agreement.
5. Regular Review Is Key
   Beyond the Connelly ruling, business and tax laws are constantly evolving. Scheduling regular reviews of your buy-sell agreement with an advisor can help keep your succession plan aligned with your goals and compliant with the latest regulations.

What’s Next?

If you haven’t reviewed your buy-sell agreement considering the Connelly decision, now is the time. Here’s how to approach it:

• Understand the potential impact of the Connelly ruling on your estate plan. This can help you identify whether your agreement needs restructuring to minimize tax exposure.
• If your buy-sell agreement is funded by life insurance, consider whether cross-purchase agreements or other alternatives could reduce your estate tax liabilities.
• The Connelly decision serves as a reminder that tax laws are dynamic. Being proactive and flexible in your planning can help you better navigate future changes.

The Connelly v. U.S. decision has raised the stakes for buy-sell agreements, especially those funded by business-owned life insurance. By reassessing your agreement now, you can address potential tax risks and adapt your strategy to safeguard your business’s future. Remember, a well-structured buy-sell agreement is not just about tax efficiency; it’s about ensuring legacy, continuity, security and peace of mind for your business and your family. 

Connect with us to explore how we can help you navigate these complexities and secure your business's future!