How the Connelly Ruling Affects Buy-Sell Agreements and estate tax implications.

As a business owner, safeguarding your business’s future is critical, and for many, life insurance-funded buy-sell agreements play a central role in succession planning. However, a recent Supreme Court ruling in Connelly v. U.S. affects buy-sell agreements and estate tax implications—and ultimately, your business.

The Connelly decision mandates that life insurance proceeds used to fund the redemption of a deceased business owner’s shares must now be included in the business’s estate valuation for tax purposes. This ruling presents a potential tax trap for many business owners relying on entity purchase or stock redemption agreements, as it could significantly inflate estate values, increasing the overall tax burden at death. With estate taxes potentially reaching 40%, this could drastically reduce the wealth passed on to your heirs or partners.

Why This Matters for Business Owners

Previously, many business owners leveraged life insurance proceeds in these buy-sell agreements to provide liquidity for seamless transitions. For example, when a business partner passed away, the insurance payout funded the repurchase of shares, allowing surviving partners to continue operations smoothly. Now, under Connelly, those proceeds are taxable as part of the estate—meaning business owners might be unintentionally inflating their tax liability.

This shift raises significant concerns for those with entity purchase agreements, as it could result in a higher-than-expected business valuation at the time of an owner’s death. For businesses that have invested in estate planning or those looking to transition ownership efficiently, this can be a costly oversight.

Exploring Alternative Solutions

Given this new legal framework, it’s essential to reevaluate your current buy-sell agreements. One potential strategy is shifting from an entity purchase or stock redemption agreement to a cross-purchase agreement. Unlike entity purchase agreements, in cross-purchase setups, each business partner owns a life insurance policy on the other, and the payout does not affect the business valuation.

This structure can help mitigate the estate tax consequences triggered by Connelly, allowing the surviving partners to purchase the deceased partner’s shares directly. Though cross-purchase agreements tend to work best for smaller businesses with fewer partners, this alternative can prevent the unwanted tax burdens now posed by entity purchase agreements. Additional strategies  for common buy-sell techniques include:

• Entity purchase/Stock redemption
• Cross purchase
• Wait-and-see
• Right of first refusal
• One-way buy-sell
• Trusteed buy-sell
• Cross endorsement buy-sell
• Special purpose LLC buy-sell
• Wealth transfer techniques
• Funded or unfunded

Time to Act

As the tax environment evolves, so must your financial planning strategies. At Cestia Wealth Management, we educate business owners on the changing landscape. It’s important to act now by working with a financial advisor to review your existing agreements and explore more tax-efficient options.

Don’t wait until it’s too late—get in touch with us today to learn how the Connelly ruling affects buy-sell agreements and estate tax implications.

 

SOURCES

1. Adopted by Securian Financial
2. Connelly v. US, 144 S Ct 1406. (2024)
3. Connelly v. United States, Case No. 4:19-cv-01410-SRC (E.D. Mo. Sep. 21, 2021)
4. Estate of Blount v. Commissioner, 428 F.3d 1338 (11th Cir. 2005)
5. Estate of Cartwright v. Commissioner, 183 F.3d 1034 (9th Cir. 1999)
6. Connelly v. United States, 70 F4th 412 (8th Cir. 2023)
7. Connelly v. United States, 70 F4th 412, (8th Cir. 2023), cert. granted, 2023 WL 8605743, No. 23-146 (S.Ct. Dec. 13, 2023)
8. https://ballotpedia.org/Connelly_v._Internal_Revenue_Service (p. 46) Id.
9. (pp 50-51)
10. Connelly v. US, 144 S Ct 1406. (2024)

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