Attention owners of closely held businesses! A recent decision by the Supreme Court could impact the amount of taxes owed by your estate at death. In Connelly v. United States, the Supreme Court held that the value of life insurance proceeds received by a closely held corporation upon the death of an owner increases the fair market value of the corporation for estate tax purposes. Connelly overturns a previous understanding that a company’s contractual obligation to redeem (purchase) a deceased owner’s shares in the business offsets the value of life insurance proceeds earmarked for that redemption. Since there was no offset, the taxpayer in Connelly owed additional federal estate tax reflecting the (post-death) increased value of his shares in the corporation. Thus, because redemption obligations no longer offset the value of life insurance proceeds, closely held businesses will need to reassess insurance funded redemption arrangements to avoid adverse federal estate tax consequences for their owners.

Additionally, Connelly illustrates the importance of defensible valuation methods under buy-sell agreements. For estate tax purposes, the law disregards the value set by buy-sell agreements unless the agreement sets the fair market value of the business. The requirements to determine fair market value of a closely held business are set forth in Section 2703 of the Internal Revenue Code. In Connelly, the buy-sell agreement ultimately did not control the value of the closely held corporation for estate tax purposes. While the Supreme Court did not specifically address whether the agreement could have withstood Section 2703, Connelly demonstrates what not to do when determining the value of closely held businesses under buy-sell agreements. Failure to properly value the business, as was the case in Connelly, could lead to higher valuations for estate tax purposes. As such, Connelly demonstrates the importance of defensible valuation methods to avoid unintended estate tax consequences.