Life Insurance, Stock Redemption, and Your Business

A New Wrinkle from the Supreme Court

By Benjamin M. Coyle, Esq. and Isabelle Fergus

A recent Supreme Court case ruling may have you making some important changes to life-insurance policies owned by your company. In early June, the Supreme Court unanimously ruled that proceeds from life-insurance policies used to buy out a deceased owner’s shares of a business are not offset by redemption obligations, which effectively results in the value of the company being increased.

In Connelly v. United States, the Supreme Court affirmed the lower court’s ruling that the obligation of the company to redeem shares at fair market value does not offset the value of life-insurance proceeds and that life-insurance proceeds must be included in the company’s valuation. The decedent’s estate argued that this decision made by the court will make succession planning increasingly difficult for closely held corporations, and he is right.

Benjamin Coyle

“The question here is whether Crown’s contractual obligation to redeem Michael’s shares at fair market value offsets the value of life-insurance proceeds committed to funding the redemption. The answer is no.”

In summary, Thomas Connelly, as executor of the estate of Michael P. Connelly Sr., sued the U.S. for a refund of the estate taxes assessed against Michael Connelly’s estate. Michael and Thomas Connelly owned a building-supply corporation known as Crown C Supply (“Crown”). Michael owned a 77.18% stake in the company, while Thomas owned the rest. The brothers had a buy-sell agreement that required the company to be valued as of the date of death of a shareholder.

Crown purchased a $3.5 million life-insurance policy on each brother’s life. The life insurance was to be used by Crown to buy the deceased brother’s shares if the other brother did not want to buy the shares personally. Thomas determined that he did not want to buy Michael’s shares, and therefore Crown was obligated to do so. This is where the valuation of Crown comes into play.

Thomas argues that Crown was worth $3.86 million before the redemption, and Michael’s shares were worth $3 million. He also claims that Crown was worth $3.86 million after Michael’s shares were redeemed. In the court’s eyes, both of Thomas’s claims cannot be true.

In granting summary judgment to the IRS, the lower court reasoned that it found that the stock-purchase agreement did not affect the valuation and, furthermore, that a proper valuation of Crown must include the life-insurance proceeds that were used toward redemption because it is seen as significant asset of the company, making Crown not worth $3.86 million, but $6.86 million.

The question here is whether Crown’s contractual obligation to redeem Michael’s shares at fair market value offsets the value of life-insurance proceeds committed to funding the redemption. The answer is no. The Supreme Court affirms that Crown’s contractual obligation to redeem Michael’s shares did not diminish the value of those shares because redemption obligations are not seen as liabilities that reduce a corporation’s value for federal estate tax.

Impact of the Ruling

So, how does this recent decision affect companies that have existing stock-redemption agreements? It means that the business must review their existing agreements and the manner in which the company and shareholders are obligated pursuant to its terms.

It is essential to review these agreements with your advisors, including your accountant and attorney. There are various options that may be utilized, each of which have significant consequences, and should not be done without consultation with your advisors, as the decisions will have an impact on the business and estate planning.

When looking into life-insurance policies, you may want to consider a cross-purchase agreement where the shareholders will purchase life insurance on each other. In doing so, this ensures insurance proceeds will go right to purchasing the deceased shares without the estate’s tax values rising. Although this was the better option for Thomas and Michael’s situation, this type of agreement requires each shareholder to pay premiums for the insurance policy, creating a risk that one may not be able to pay it. While this type of arrangement may be beneficial in some respects, it may have negative consequences as well.

Another key step is to regularly get valuations to see potential tax impacts and to see current market values and tax regulations. Consulting tax and legal experts on this matter will help to ensure that your corporate agreements align with all current laws and regulations. Along with talking to legal experts, you should also expect to plan for future tax obligations, whether that means setting aside funds and/or developing financial strategies to cover potential tax liabilities that could potentially rise from share redemptions or corporate obligations.

By taking steps to review agreements and evaluate life-insurance policies by consulting with experts, business owners can manage their estates better and minimize tax liabilities, all while establishing effortless ownership transitions within their business.

Ben Coyle is a shareholder with Bacon Wilson who focuses much of his practice in the areas of municipal law and litigation, while also handling probate and business matters. Isabelle Fergus is an intern at Bacon Wilson who is attending the Isenberg School of Management at UMass Amherst.