Buy-Sell Agreements: Implications Following Recent Supreme Court Decision

Matthew Arey, JD* – Director of Fiduciary Services, Retirement Plan Advisor

June 2024

A relatively narrow holding from a unanimous Supreme Court (SCOTUS) decision highlights the importance of reviewing buy-sell agreements in closely held businesses.

Often, busy entrepreneurs and small business owners overlook the intricacies of business ownership. Shares, partnership interests, and other types of incorporated and non-incorporated businesses are property interests. Like owning a piece of land, these interests are generally transferrable, and pass according to one’s estate plan upon the owner’s death. One’s estate plan is often comprised of a combination of properties that pass by contract, will, trust, and unfortunately, intestate.

Small business owners often manage and control their business enterprises with a combination of individuals who are familial and unrelated. To assist the business owner with planning for one’s mortality, many attorneys, CPAs, and financial advisers, recommend that life insurance be utilized to provide an inflow of capital to purchase the business owner’s property interest from their estate following death. This allows the business to continue after the loss of one of its key members partially unencumbered with additional financial burdens.

In Connelly v. United States,¹ the Supreme Court addresses a common situation for small business owners. Michael and Thomas Connelly were brothers and jointly owned a building supply corporation, called Crown C Supply (Crown). Michael owned approximately 77% and Thomas the remaining 23% of the outstanding interests in Crown C Supply. Michael and Thomas (the Connellys) had entered into an agreement to purchase each-others ownership in Crown in the event of either’s death. If either declined to purchase the other’s interest, Crown was required to repurchase the deceased owner’s interest. The Connellys funded their agreement utilizing $6.0(m) of life insurance 3.0(m) on each sibling’s life that was payable to Crown at the death of either sibling. This cash infusion at death was “earmarked” to repurchase the deceased sibling’s interest.

When Michael passed away, Thomas declined, to purchase Michael’s interest personally, instead opting for Crown to repurchase Michael’s interest. Crown received $3.0(m) in life insurance proceeds and repurchased the shares, as required. Thomas—the executor for Michael’s estate—filed the required IRS estate tax filings, excluding the value of the life insurance proceeds. The IRS audited the estate’s tax filing and asserted a tax deficiency of $889,914, arguing that Crown’s value was increased by the insurance proceeds since there was no corresponding liability offsetting the life insurance proceeds.²

Following the IRS audit, Thomas hired an analyst to review the valuation of Crown. The analyst, too, relying on earlier case law, excluded the life insurance cash proceeds, from Crown’s business valuation, asserting that although Crown received cash the business had a corresponding liability to repurchase Michael’s shares.³ The IRS took the opposite position, asserting that Crown’s value was increased by the insurance proceeds, and that there was no corresponding liability offsetting the cash asset.

The Supreme Court sided with the IRS holding that for federal estate tax purposes, the cash proceeds increased the valuation of Crown, and that the stock redemption agreement between Crown and the Michael’s estate, did not constitute an offsetting liability for federal estate tax purposes.⁴ The Supreme Court noted specifically, that there are often pros and cons with any estate planning strategies, stating “[t]here were other options. For example, the brothers could have used a cross-purchase agreement—an arrangement in which shareholders agree to purchase each other’s shares at death and purchase life-insurance policies on each other to fund the agreement. . . . A cross-purchase agreement would have allowed Thomas to purchase Michael’s shares and keep Crown in the family, while avoiding the risk that the insurance proceeds would increase the value of Michael’s shares.”⁵ The holding makes it very important to review the current structure of life-insurance proceeds in cross-purchase agreements, and stock redemptions, and if necessary review with your counsel.

How can Lebel & Harriman help?

For over 40 years, Lebel & Harriman has specialized in providing funding solutions for buy-sell agreements. If you have any questions or need assistance in optimizing your business succession plan, we encourage you to reach out to ensure your business and legacy are protected.

1. Connelly v. United States, 602 U.S. _____ (2024) ↩︎
2. Connelly v. United States, 602 U.S. _____ (2024) ↩︎
3. Connelly v. United States, 602 U.S. _____ (2024), quoting Estate of Blount v. Commissioner, 428 F. 3d 1338 (CA11 2005). Holding that insurance proceeds should be “deducted . . . from the value” of a corporation when they are “offset by an obligation to pay those proceeds to the estate in a stock buyout.” ↩︎
4. Connelly v. United States, 602 U.S. _____ (2024) ↩︎
5. [5] Connelly v. United States, 602 U.S. _____ (2024); Additional reference to S. Pratt, Valuing a Business 821 (6^th ed. 2022). ↩︎

This document is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.

*Although licensed to practice law, Matthew does not provide legal services for clients. Attorney-Client privilege does not apply to communications. Lebel & Harriman is not a law firm. The information contained in this communication, including its attachments, is not protected information and may be subject to disclosure to the full extent of the law.