Supreme Court Hands IRS 9-0 Victory – Say Goodbye to Your Estate Tax Refund!

Olga Maksimava /
Olga Maksimava /

The Supreme Court’s recent decision has significant implications for estate planning, particularly for family-owned corporations. On June 6, the court unanimously ruled in favor of the IRS in Connelly v. Internal Revenue Service, which concerns the tax treatment of life insurance proceeds used to redeem a decedent’s shares in a closely held corporation.

Justice Clarence Thomas authored the court’s 9–0 decision, addressing a dispute involving the Connelly brothers’ closely held business. Following Michael Connelly’s death, disagreements arose between tax authorities and the estate regarding the value of his shares in Crown C Corporation, a building materials company based in St. Louis.

Like many family-owned businesses, Crown C Corporation had a buy-sell agreement in place. These agreements are standard in closely held corporations to ensure business continuity and family control after a shareholder’s death. Such contracts often involve the company purchasing life insurance on the shareholders to fund the buyout of the deceased owner’s shares.

When Michael Connelly passed away in 2013, he owned 77.18% of Crown C Corporation, while his brother, Thomas Connelly, held the remaining 22.82%. The executor of Michael’s estate reported the value of his shares as $3 million on the estate tax return. However, the IRS audited the return and valued the shares at over $3.8 million, factoring in the life insurance proceeds, which pushed the company’s total value to $6.8 million.

The central issue was whether the life insurance proceeds should be included in the valuation of Michael’s shares for estate tax purposes. The IRS argued that the proceeds were part of the company’s assets and should be included in the valuation. The estate contended that these proceeds were meant to fund the buyout of the shares and should not be taxed.

The U.S. Court of Appeals for the 8th Circuit sided with the IRS, a decision that the Supreme Court subsequently upheld. The court’s ruling emphasized that life insurance proceeds used for share redemption must be considered when calculating the value of the decedent’s shares for estate tax purposes.

This ruling points out the importance of understanding how different estate planning tools affect tax liabilities. The court’s decision clarifies that life insurance proceeds used in buy-sell agreements are not exempt from estate tax calculations. For family-owned businesses, this means a potentially higher estate tax burden.

Justice Thomas noted that the valuation of closely held business shares must reflect their fair market value at the time of the owner’s death, including any life insurance proceeds intended for share redemption. The court found that these proceeds are indeed corporate assets that influence the business’s overall value.

Family-owned businesses should revisit their estate planning strategies, particularly how they structure buy-sell agreements and life insurance policies, to minimize tax liabilities. It is crucial to consult with financial advisors and tax professionals to ensure that the estate plans align with current tax laws and maximize tax efficiency.

Here are a few steps to consider:

Review Buy-Sell Agreements: Ensure that these agreements are structured to reflect the actual fair market value of the business and comply with tax regulations.

Life Insurance Policies: Evaluate how life insurance policies are used within the company. Consider alternative funding mechanisms for buy-sell agreements that offer better tax advantages.

Regular Valuations: Conduct regular valuations of the business to stay updated on its fair market value. This practice can help in accurate estate planning and avoid unexpected tax liabilities.

Professional Guidance: Work with estate planning professionals who can provide tailored advice and keep abreast of legal changes that might affect your business.

The Supreme Court’s decision in Connelly v. IRS serves as a crucial reminder for family-owned businesses to consider the tax implications of their estate planning strategies carefully. By including life insurance proceeds in the valuation of shares, the court has highlighted the need for meticulous planning and professional guidance to ensure that these strategies are practical and tax-efficient.

Staying proactive and informed can help preserve the business’s value for future generations while minimizing unexpected tax burdens.