SCOTUS Holds That Life Insurance Proceeds Used To Finance Stock Purchase Agreements Do Increase The Value Of Closely Held Corporations For Estate Tax Purposes

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On June 6, 2024, the Supreme Court of the United States ruled that life-insurance proceeds required to be used to redeem stock of a deceased shareholder must be included in the value of the company...
United States Corporate/Commercial Law
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On June 6, 2024, the Supreme Court of the United States ruled that life-insurance proceeds required to be used to redeem stock of a deceased shareholder must be included in the value of the company for purposes of determining the deceased shareholder's gross estate. The Court affirmed the holding of the Eighth Circuit Court of Appeals in Connelly v. United States.

In Connelly, two brothers and shareholders of a C Corporation ("Crown") entered into a stock-purchase agreement with Crown, stipulating that if one brother passed away, the surviving brother would redeem the deceased brother's shares. If not, Crown would be obliged to redeem the shares. To finance potential future stock redemptions, Crown acquired life insurance policies on both brothers. When one of the brothers passed away in 2013, Crown received $3.5 million in life insurance proceeds, of which $3 million was used to redeem the shares. The executor of the deceased shareholder's estate valued the company based on the redemption price, which did not take the value of the life insurance policy into account.

After an audit, the IRS issued a notice of deficiency finding that the $3 million of life insurance proceeds used for the redemption should have been included in the company's valuation. When the case made its way to the Eight Circuit, the estate relied on the Eleventh Circuit's holding in Estate of Blount v. Commissioner, where the court found that life insurance proceeds owned by a corporation did not raise the company's stock value because they offset the obligation to redeem the decedent's shares. However, the Eight Circuit disagreed and held that the life insurance proceeds did increase the value of the company and that the obligation to redeem the shares was not a typical obligation. The executor appealed to the Supreme Court, which agreed to hear the case.

But the Court unanimously resolved the Circuit split in favor of the government because "a corporation's contractual obligation to redeem shares at fair market value does not reduce the value of those shares in and of itself[.]" Rejecting the executor's argument that a potential buyer would not consider the insurance proceeds as part of the value of the company, Justice Thomas wrote that the inquiry here should focus on what Crown was worth at the time the shareholder died. "Because a fair-market-value redemption has no effect on any shareholder's economic interest, no willing buyer purchasing Michael's shares would have treated Crown's obligation to redeem Michael's shares at fair market value as a factor that reduced the value of those shares."

Acknowledging that the opinion will make estate planning more difficult for owners of closely held private corporations, the Court stated that "every arrangement has its own drawbacks." But the Court pointed out that the brothers could have used a cross-purchase agreement where each brother purchased a life insurance policy on the other to finance the agreement without inflating the value of the corporation. Ultimately, the Court found that the arrangement the brothers entered into here increased the value of the corporation for estate tax purposes.

For further questions regarding this topic, contact Liskow attorneys Leon Rittenberg III, John Rouchell, Caroline Lafourcade, and Kevin Naccari, Jr. and visit our Estate Planning practice page.

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