Connelly v. United States: What it May Mean For Your Business
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Last month I spoke to the importance of a buy/sell agreement amongst business owners. To continue that conversation, the recent Supreme Court decision in Connelly v. United States has given even more for small business owners to consider. The case has significant implications that extend well into the owner’s estate planning, and it should prompt them to reconsider how they handle succession plans and ownership structures, especially when buyout agreements are involved. In this article, we’ll break down the key lessons from this case and how they could affect your business.
A Quick Look at the Connelly Case
In Connelly v. United States, the Supreme Court addressed the valuation of life insurance proceeds used in business buyouts, specifically for estate tax purposes. The case involved two brothers, Thomas and Michael Connelly, who co-owned Crown C Supply, a closely held C corporation. They had a buyout agreement in place that allowed the company to redeem the deceased brother’s shares using life insurance proceeds. The crux of the legal dispute was whether those life insurance proceeds should be included in the company’s value for estate tax purposes.
The IRS contended—and the Court agreed—that life insurance proceeds used for this kind of buyout must be counted as a corporate asset when determining the value of the business. This decision increases the taxable value of estates in similar situations and has several important consequences for business owners, especially those relying on life insurance-funded buyouts.
What This Ruling Means for Small Business Owners
If you’re a small business owner or operate a closely held company, Connelly raises serious questions about how buyout agreements are structured and the role of life insurance in those agreements. For many, this decision should serve as a wake-up call to reassess existing plans. Here are some key areas that deserve your immediate attention:
Reevaluate Your Buy-Sell Agreement
Buy-sell agreements are designed to ensure business continuity when an owner passes away or exits the business. In many instances, life insurance policies fund these agreements, with the company using the proceeds to buy out the deceased owner's shares. Prior to Connelly, many business owners believed that the obligation to redeem shares would offset the life insurance value when calculating the company's estate tax valuation. That’s no longer the case.
What you should consider: If your current buy-sell agreement is structured as a redemption agreement (where the business purchases the shares), you could face a higher estate tax bill than anticipated. Now might be the time to explore restructuring your agreement into a cross-purchase plan. In this structure, surviving owners directly purchase the deceased owner's shares, with life insurance proceeds going to them, not the company—thus avoiding an increase in the company’s valuation for tax purposes.
Review Your Estate Plan
The Court’s decision underscores that life insurance proceeds—even when earmarked for business continuity—are considered part of the business’s taxable value. This could dramatically alter the estate planning outcomes for business owners who have carefully crafted their plans to minimize tax burdens.
The estate tax exemption is set to decrease significantly in 2026 as the Tax Cuts and Jobs Act (TCJA) sunsets, and many states have even lower thresholds than the federal government. This ruling could make the difference between owing estate taxes or avoiding them altogether.
What you should consider: Now is a great time to work with your estate attorney to reassess your plan. If life insurance is part of your business’s buy-sell structure, consider whether a cross-purchase arrangement or a trusteed buyout might offer better protection from the kind of tax exposure highlighted in Connelly.
Prepare for Broader Financial Implications
The valuation changes resulting from Connelly aren’t limited to estate tax—they could affect your business’s financial health as well. Increasing the company’s value due to life insurance proceeds could put unexpected pressure on liquidity and cash flow. If your heirs are forced to sell assets or take on debt to cover an unanticipated tax bill, the future stability of your business—and your intended legacy—could be at risk.
What you should consider: You may want to consider purchasing additional personal life insurance to cover potential estate taxes resulting from a redemption agreement. Alternatively, you might explore restructuring the business to protect its value through trusts or family-owned LLCs, which are designed to limit estate tax exposure.
Cross-Purchase Arrangements: A Smarter Option?
One of the biggest lessons from Connelly is that cross-purchase arrangements, where individual owners hold life insurance policies on each other, may offer better protection against valuation complications. With a cross-purchase arrangement, the business’s value remains insulated from life insurance proceeds, and surviving owners receive a stepped-up basis in the shares they purchase.
What you should consider: If your business has multiple owners, a cross-purchase agreement may be a more attractive option than a redemption agreement. While cross-purchase plans can be more complex to manage—especially as the number of owners increases—they can offer significant tax advantages over time. Just keep in mind that each owner will need to hold policies on the others, which can complicate the arrangement.
The Bottom Line
The Connelly decision is a reminder of how critical it is to keep a close eye on the structure of your business succession plans. For closely held businesses that rely on life insurance to fund buyouts, the landscape has shifted in ways that could have serious financial repercussions.
Now is the time to review your buyout or succession planning agreements. Determine whether a redemption or cross-purchase arrangement is the best fit for your business, and make sure your estate planning documents reflect the current legal and tax environment. While Connelly may not be the final word on these matters, it’s a clear call for business owners to be proactive and thoughtful about how they plan for the future.
Smart planning today will go a long way in protecting your business and ensuring your legacy.
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The Supreme Court's Connelly decision reshapes estate planning and buy-sell agreements for business owners.