The Supreme Court Blows Up a Popular Small-Business Succession Plan
The U.S. Supreme Court’s decision in Connelly v. United States has complicated a common succession strategy used by many small-business owners. Typically, companies purchase life insurance on their owners to fund the repurchase of stock when an owner dies, with the aim of making the insurance payout tax-free and avoiding the burden of funding the repurchase from operating profits. However, the Court ruled against this strategy, causing significant financial repercussions. The estate of the deceased owner in the Connelly case faced an additional $900,000 in estate taxes, highlighting the potential pitfalls of this approach and the need for business owners to stay vigilant about tax and legal issues.The case of Michael and Thomas Connelly, owners of Crown C Supply, exemplifies the impact of the ruling. After Michael’s death, the life insurance payout intended to fund the repurchase of his shares was deemed part of the company’s value, thus increasing the estate tax liability. The Supreme Court’s unanimous decision, written by Justice Clarence Thomas, overturned previous interpretations that excluded such payouts from a company’s value due to offsetting liabilities. Instead, the Court determined that the requirement to repurchase shares did not constitute an ordinary liability but rather provided value to the firm, resulting in a higher estate tax for Michael’s estate.
To mitigate the effects of the Connelly decision, business owners should review their buy-sell agreements, ensure proper valuation of their companies, and consider alternative arrangements such as cross-purchase agreements. These alternatives can help avoid inflating the company’s value and the deceased owner’s estate, though they come with their own challenges, particularly for companies with multiple owners. Professional advice is crucial in navigating these complexities, and while it may be costly and divert attention from business operations, it is essential to prevent unexpected estate-tax burdens.
For more information see Laura Saunders “The Supreme Court Blows Up a Popular Small-Business Succession Plan” The Wall Street Journal, July 12, 2024.
Special thanks to Joel C. Dobris (Professor of Law, UC Davis School of Law) for bringing this article to my attention.