US Supreme Court Case Impacts Business Estate Taxation Value
First Citizens Wealth INTEL: Insights and News—Taxation, Election & Legislation
Each month, we'll cover time-sensitive updates on tax, election and legislation developments that could affect you.
The June 2024 Supreme Court decision in Connelly v. Internal Revenue Service held that a corporation's stock redemption agreement doesn't offset the value of life insurance policy proceeds applied to fund the redemption.
Who is impacted
Owners of closely held businesses who have set up company-owned life insurance are impacted by this decision. A business is considered closely held when more than half of its stock is owned directly or indirectly by five or fewer individuals at any time in the second half of the year. In these businesses, when an insured shareholder dies, the insurance proceeds can be used by the company to buy back the decedent's shares through a stock redemption agreement.
What changed
Before Connelly v. Internal Revenue Service, life insurance proceeds received by the business and used to redeem the decedent's interest in the business could be offset against taxation.
After Connelly, these proceeds are held to be a net corporate asset. Instead of reducing tax liability when used to buy the decedent's shares, the death benefit is now classed as a net increase in the estate tax value of the business. This also increases the value of the decedent's gross estate. The value of the company plus the value of the insurance proceeds are included.
What action is required
Business owners should understand that the increase in value resulting from the Connelly case could push them past the threshold from a tax-sheltered estate to a taxable estate. This likelihood could increase if the Tax Cuts and Jobs Act sunsets at the end of 2025 and the estate tax exemption amount reverts to $5 million—indexed for inflation. It's important to consider the following questions now.
- Do you have a stock redemption agreement in place? If so, is it funded by company-owned life insurance?
- Do you know the basis of the agreement? For example, is it a cross-purchase agreement?
- Have there been changes in the structure or value of your business since the redemption agreement was put in place?
- Do you know your state's estate tax threshold?
When you should act
Connelly has already gone into effect, and immediate action is indicated. You may have a cross-purchase arrangement in place—set up as a trusteed cross-purchase or with an LLC to hold the insurance. It's still a good idea to have that structure reviewed by a lawyer, accountant or other qualified advisor to identify and avoid any unexpected tax consequences. It's also worth considering the wider implications if the Tax Cuts and Jobs Act does sunset.
Who you should talk to now
For more information on Connelly v. Internal Revenue Service and its potential impact on estate tax value, you can explore the overview of the Supreme Court's decision (PDF) or speak to a First Citizens wealth consultant today.
