In early June, the Supreme Court of the United States (SCOTUS) issued a monumental ruling in Connelly v. Internal Revenue Service – influencing the unintended consequences of insurance ownership by a company for succession plan purposes. This critical decision ushers in a game-changing precedent for how life insurance-funded buy-sell agreements are owned, while also providing guidance for financial partners to interpret future valuations and estate tax exposure.
With the anticipated sunset of the current $13.6 million individual estate tax exemption in 2025, a far lower taxable estate threshold should be expected. This ruling will serve as a catalyst for anyone with estate exposure in excess of $5 million to carefully review current buy-sell agreements, underlying insurance policies, objectives, and ownership structure.
The Connelly Ruling
Connelly v. Internal Revenue Service centered around the argument that when a policy is owned by the company outright to fund future share purchase activity from deceased owners, the lump sum liquidity becomes an asset of the company, effectively raising the post-mortem company per share valuation.
SCOTUS ruled that the company’s contractual obligation to purchase shares owned by the deceased owner’s estate is not a liability of the company to be used as an offset for the insurance proceeds. This valuation determination is supported by the assumption that a prudent investor would be willing to pay a per share value that includes recently received insurance proceeds.
What This Means for Clients
Following this ruling, careful consideration should be given to the structure of current and future buy-sell agreements, with the Connelly ruling now presenting new potential tax implications of having the entity own policies and how future policy maturities will impact valuations.
To circumvent unintended consequences of this new ruling, advisors and business owners must review current structures and implement strategies immediately. Company leadership should consider the use of cross-purchase agreements, providing individual insurance contract ownership in lieu of company-owned policies. The use of Irrevocable Life Insurance Trusts (ILITs) or structures, such as partnerships and LLCs, could also nullify adverse tax exposure.
Insurance policies, corporate structure, and company valuation should also promptly be assessed following the Connelly ruling. At Farther, our expert advisors not only provide holistic strategic consulting, but also the capacity to implement trust and insurance strategies to protect all interested parties.
We invite you to connect with a Farther wealth advisor for questions related to how the Connelly ruling might impact you and your business.
