The Supreme Court’s unanimous ruling in Connelly v. United States represents a significant shift in estate tax valuation principles and succession planning strategies for closely held businesses. This landmark decision fundamentally changes how business interests are valued for estate tax purposes, requiring immediate attention from business owners and advisors.
Case Overview
The case centered on two brothers, Michael and Thomas Connelly, the only shareholders of a building materials corporation, Crown C. Supply (“the company”), based in St. Louis. Michael held a 77.18% ownership interest. Michael and Thomas executed a buy-sell agreement providing that the surviving brother would have a right to purchase the deceased brother’s shares upon the death of the first of them. The company purchased $3.5 million of life insurance coverage for each brother.
Following Michael’s death, the company bought back his shares. The valuation used by the estate was an agreed-upon amount between the company and the estate. The estate did not obtain a formal appraisal, and the valuation used by the estate did not include the death benefit the company received at Michael’s death.
On audit, the IRS determined that the estate should have had the stock appraised and that any such appraisal would have included the 77.18% value of the death benefit. On appeal, the estate argued that the redemption value should reduce the value of the shares and offset the insurance proceeds.
Still, the Eighth Circuit observed that this agreement assumes that valuation should be based on what a willing buyer would pay for the shares after the redemption when the relevant inquiry is the value at the date of Michael’s death, which necessarily is before the redemption. The Supreme Court unanimously affirmed the court’s decision, holding that corporate-owned life insurance on the life of a deceased shareholder acquired to redeem the deceased shareholder’s stock increased the value of the stock. This ruling changes how businesses must approach their succession planning strategies.
Understanding the Estate Tax Impact
The Court’s ruling clarifies that life insurance policies owned by the corporation increase the value of the stock, and a corporation’s obligation to redeem shares does not diminish its value for estate tax purposes. This marks a significant shift from prior valuation methods and has immediate implications for estate tax planning.
Key Estate Tax Considerations
- Business valuations must reflect fair market value at the time of death
- Redemption obligations do not offset the business value for estate tax purposes
- Life Insurance proceeds received upon the shareholder’s death increase the value of the company shares
- Estate tax liability may be higher than anticipated under existing agreements
Tax Planning Strategies
Immediate Actions Required
Absent any legislative changes, the current federal estate tax exemption of $13.990,000 million (2025) is set to decrease significantly after December 31, 2025. Combined with the Connelly decision, this creates urgency for tax planning. Business owners should:
- Reassess current business valuations
- Review existing redemption agreements
- Evaluate alternative ownership transfer structures
- Consider accelerated gifting strategies
Long-term Planning Considerations
Estate planning strategies must now account for the following:
- Higher potential estate tax valuations
- Modified basis step-up calculations
- Alternative transfer methods to minimize tax exposure
- Structured gifting programs to utilize current exemption levels
Strategic Estate Planning Solutions
Entity Structure Review
The ruling necessitates a thorough review of the following:
- Corporate structure optimization
- Ownership transfer mechanisms
- Valuation discount opportunities
- Funding strategies for estate tax payments
Tax-Efficient Transfer Strategies
Consider implementing:
- Modified buy-sell structures
- Grantor trust arrangements
- Family limited partnerships
- Structured gifting programs
- Life Insurance Trusts
How Grassi Can Help
Our team of experienced estate and tax planning professionals can help:
- Analyze your current business structure and succession plans
- Develop tax-efficient transfer strategies
- Design comprehensive estate plans
- Create liquidity for estate tax obligations
- Provide ongoing guidance as tax laws evolve
Contact our team to ensure that your estate plan and business secession strategies are properly structured in light of this significant ruling.
