Overview
For decades, companies have used corporately owned (“entity owned”) life insurance to “buy-out” the share of a deceased partner. The insurance policy was not viewed as an asset of the company and, therefore, did not affect the estate’s valuation for estate tax purposes. On June 6, 2024 that all changed! The U.S. Supreme Court ruled in Connelly v. United States that Entity Purchased Life Insurance IS an asset of the company and, as such, will now increase the owner’s individual estate valuation for federal estate tax purposes.
Because 40% of all current buy-sell agreements are funded with entity-owned life insurance, it is critical that every business reviews their current plans to determine if their plans need to be changed to avoid the punitive result of Connelly.
What are Entity-Purchase Agreements?
- The Operating Agreement or Partnership Agreement provides that the business will purchase and own life insurance on each of the partners. At the passing of a partner, the life insurance is paid to the business which then distributes the proceeds to the decedent’s estate in exchange for his or her share of the business.
- Post-Connelly, life insurance proceeds increase the company’s value and thereby result in a cooresponding increase to the estate valuation for taxation purposes.
What are Cross-Purchase Agreements? (Legacy Recommended)
- The Operating Agreement or Partnership Agreement provides that Each owner buys life insurance on the others and personally uses the proceeds to buy the deceased’s shares of the business.
- Avoids insurance proceeds being included in the company’s value.
- More complex with multiple owners, but much more tax efficient post-Connelly.
Recommended Action Steps
- Audit all existing operating agreements for their buy-sell structure.
- Consider transitioning to a Cross-Purchase structure.
- Coordinate with Legacy Trust & Capital Partners’ Estate and Business Planning Teams to evaluate tax exposure.
Conclusion
The Supreme Court’s Connelly decision has rendered many traditional entity-purchase buy-sell agreements obsolete or dangerous from an estate tax perspective. Businesses and owners should act quickly to review their agreements to avoid unintended tax burdens.
Please contact our office to schedule a buy-sell agreement review or consultation.
Legacy Trust & Capital Partners
