Supreme Court Ruling Impact on Corporate Estate Tax Planning

Tax

Executive Summary

The U.S. Supreme Court unanimously ruled that life insurance proceeds a corporation receives to fund a share redemption agreement increase the corporation’s estate tax value. The case involved Crown C Supply, a small building supply company, and the IRS. The court stated that after the death of a shareholder, the value of their shares must reflect the corporation’s fair market value, including insurance proceeds meant to fund a share redemption. The decision affirms an earlier ruling in favor of the IRS, which had disagreed with the estate’s valuation of shares, leading to additional taxes for the estate. The Supreme Court concluded that the result is a consequence of how the shareholders chose to structure their agreement.

 

Supreme Court Ruling Impact on Corporate Estate Tax Planning

 

The U.S. Supreme Court recently issued a ruling that has significant implications for corporate estate tax planning. In a unanimous decision, the court held that life insurance proceeds received by a corporation to fund a share redemption agreement increased the corporation’s estate tax value. The court further ruled that the corporation’s obligation to redeem the shares did not constitute a liability that decreased the corporation’s value (Connelly, No. 23-146 (U.S. 6/6/24)).

The case under consideration involved two brothers, Michael and Thomas Connelly. They were sole shareholders of their small building supply corporation, Crown C Supply. Wishing to keep the corporation within the family, the brothers agreed that upon the death of one, the surviving brother would have the option to buy the deceased brother’s shares. If the surviving brother declined, Crown C was obligated to purchase the shares. To ensure the company had the necessary funds for this, the brothers had taken $3.5 million in life insurance on each other.

When Michael Connelly passed away in 2013, Thomas declined the option to purchase his brother’s shares. Crown C, therefore, was obligated to buy the shares. Michael’s estate filed a federal tax return listing his shares’ value at $3 million based on the redemption amount. However, the IRS disputed this claim, arguing that the life insurance proceeds increased Crown C’s total value, which they set at $6.86 million. This led to an additional tax payment of $889,914, which the estate paid, and Thomas Connelly sued for a refund.

The Supreme Court’s decision affirmed the IRS’s stance, stating that an obligation to redeem shares at fair market value does not offset the value of life insurance proceeds that are set aside for the redemption. Moreover, no potential purchaser of Michael’s shares would have considered the company’s obligation to redeem these shares as a factor that reduced their value.

This ruling has significant implications for succession planning for closely held corporations. The court’s decision suggests that succession planning should take into consideration the potential impact on estate taxes of life insurance proceeds used to fund share redemption agreements. 

The Connelly case underlines the importance of careful planning and structuring of agreements when it comes to estate tax planning for corporations. The court’s ruling clarifies that the value of a deceased shareholder’s interest reflects the corporation’s fair market value, including any insurance proceeds intended to fund share redemption.

In conclusion, the Supreme Court’s ruling in the Connelly case has set a precedent that will influence estate tax planning for corporations. It emphasizes the importance of considering potential tax implications when structuring share redemption agreements funded by life insurance proceeds. This ruling will likely influence future corporate succession planning, making it even more crucial for corporations to seek expert financial and legal advice when planning for the future. 

This landmark decision will undoubtedly serve as a reference point for corporations, tax professionals, and legal advisors navigating the complex landscape of estate tax planning. It underscores the necessity for careful planning and the consideration of all potential tax liabilities when structuring agreements related to share redemption and succession planning.

For over 100 years, Packer Thomas has served generations of business owners, families, and others with tax, auditing, accounting, and information technology services. But we didn’t last that long by standing still. We’ve evolved to meet the needs of our clients who are also facing challenging changes in their financial, tax, and information technology environments.

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