Caleb Harshberger
A pair of conflicting circuit court decisions regarding estate taxes and company stock valuations are slated to clash at the Supreme Court, after the court agreed to weigh in on the dispute.
The outcome could have big implications for how companies and estates plan for the transfer of control after a shareholder dies—and on the size of the tax bill paid by the estate.
At issue is a case the Supreme Court on Wednesday agreed to hear, Connelly v. United States, involving a closely held corporation owned by two brothers. Following the death of one brother, the estate and the IRS disagreed over the stock’s proper value—a split reflected in the intermediate federal appellate courts.
The latest ruling in Connelly conflicts with an older decision, but tax pros already were advising clients to avoid the issue altogether when possible.
“Connelly was a surprise, but when you have a shareholder that controls a private company, it’s not best practice to own life insurance through that company and have the death benefit go to that company,” said Dan Potter, Grant Thornton managing director of family wealth planning services. “You should probably structure the buy-sell as a cross-purchase and have the life insurance to fund that outside the company.”
Thomas A. Connelly filed the petition fighting a $1 million tax deficiency assessed by the IRS on the estate of his brother, Michael P. Connelly. The bill came after the agency determined that Crown C Corp., a St. Louis building materials company they owned, failed to report life insurance proceeds it received after Michael’s death in 2013.
The brothers signed a stock purchase agreement to buy each other’s shares if the other died, but if the surviving brother declined to buy back those shares, Crown C Corp. would have to do so. The company then took out life insurance on both brothers to use the proceeds to buy back his shares after death. When Michael died, Thomas did not buy back his shares, so the company did—making use of the life insurance proceeds to fund the purchase.
The IRS argued that those proceeds should be considered in the valuation of the stock before the company bought back the shares.
The estate disagreed and cited a 2005 Eleventh Circuit decision, Estate of Blount v. Commissioner, which indicated that the obligation to repurchase shares under the buy-sell agreement effectively canceled out the gains from the insurance payout—meaning no boost in valuation was needed.
The Eighth Circuit ultimately upheld the IRS position—in a decision that seemed to conflict with the decision in Blount. In its appeal, the estate said the case would be an opportunity to resolve the conflicting circuit decisions.
If the court sides with Blount, share valuations—and taxes to the estate on the sale—would be much lower.
Ownership Issues
For companies looking on aghast at the confusion, tax pros say it’s best to steer clear of situations where the company is the owner of a life insurance policy for a share buyback, when possible.
Rather than companies owning the life insurance policies on owners, cross-purchase agreements let owners hold the life insurance policies apart from the company and buy out a deceased owner, leaving the company—and its valuation—out of it entirely.
Thompson Coburn LLP partner Steve Gorin said relying on the Blount case was never a surefire way to get past an audit, and he advises clients to go with the cross-purchase.
“That was a specific case in a particular jurisdiction,” Gorin said. “There are a lot of courts of appeal that aren’t the Eleventh Circuit.”
He said regardless of which argument a taxpayer thinks is right, if there’s a painless way to get the same work done—as there is in this case—go with that.
“We just want to avoid going to court with the IRS,” Gorin said. “Forget this argument here. Go do the cross-purchase.”
It can get complicated when you have many shareholders having to buy insurance for one another—but groups of owners can form LLCs to handle it in a more manageable way, Potter said.
He added many firms are implementing the cross-purchase model, and often the ones he finds in which the company owns the life insurance are older and put the policy in place a long time ago.
“The key takeaway is especially privately held business owners need to take another look at their buy-sell agreements and reconsider if counting as a mandatory buy-sell, and having insurance owned by the company, if that makes sense anymore,” he said. “In my mind, it never made sense.”
But if a shareholder declines or fails to buy the stock, as happened in Connelly, Kevin Matz, partner at ArentFox Schiff, said hybrid agreements can make sense to ensure company control.
“You’d want to do it so there’s an orderly mechanism to buy out shares,” he said.
The case is Connelly v. United States, U.S., No. 23-146.
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