Last June , the court ruled in Connelly vs . the United States that life insurance proceeds payable to a company to fund the redeeming of shares from a deceased shareholder must be included in the company ’ s fair market value when the estate tax is calculated . “ This decision has muddied the waters around buy-sell agreements by reversing generally accepted principles ,” says Marc Belletsky , a tax attorney with St . Paul , Minn . -based Securian Financial .

“ The death of an owner of a closely held business has the potential for disruption ,”

Some clients may still want a high valuation , which , though it can create stiffer estate taxes , “ may actually benefit the company or the surviving owners ,” Goldstein says . says David Goldstein , partner and trusts and estates lawyer at Farrell Fritz in New York . “ From the business ’ s perspective , the loss of a key person may impact the business ’ s ability to operate profitably . From the owner ’ s family ’ s perspective , the owner ’ s death may adversely impact the family ’ s financial situation — both because of lost income and estate taxes . To proactively address both issues , many owners in this situation will enter into buy-sell agreements during their lives .”

These agreements require either the company ( in a redemption agreement ) or the surviving owner or owners ( in a cross-purchase agreement ) to buy out the deceased owner , with the goal being to minimize disruption caused by their death , Goldstein says : “ Life insurance is often a mechanism for the company or surviving owners to fund their obligations under buysell agreements .”

In the Supreme Court case , Michael Connelly ’ s shares were valued significantly higher for estate tax purposes than for redemption purposes , says Neil Carbone , a partner and a trusts and estates lawyer at Farrell Fritz in Uniondale , N . Y . “[ Michael ’ s ] estate received $ 3 million for his shares and expected to pay $ 1.19 million in estate taxes ,” Carbone says , “ leaving his heirs with $ 1.81 million . Instead , based on the higher valuation of the shares , his estate will pay $ 2.12 million in estate taxes , leaving only $ 880,000 for his heirs .”

For business reasons , some clients may still want a high valuation , which , though it can create stiffer estate taxes , “ may actually benefit the company or the surviving owners ,” Goldstein says .

“ This may provide positive evidence to outside investors or the broader market as to the company ’ s prospects going forward . A higher valuation may also make it easier for the company to secure financing in the near term ,” Goldstein adds . “ In addition , because the basis of the deceased owner ’ s share in the hands of the purchaser will be fair market value as of the date of his death ... a higher valuation could have income tax benefits to the company and surviving owners upon a subsequent sale to third parties .”

A company planning to transition either publicly or through venture capital would seek a higher date of death valuation ( following the owner ’ s death ) that would give the new owners a more expensive business to sell to acquirers , Belletsky says .

“ One implication of Connelly is that for small-business owners considering buy-sell agreements , it is not advisable to fund a redemption agreement with company-owned life insurance ,” Goldstein says . “ It may make more sense to use cross-purchase agreements .”

— Jeff Stimpson

12 | FINANCIAL ADVISOR MAGAZINE | JANUARY / FEBRUARY 2025 WWW . FA-MAG . COM