Life Insurance Increases Share Value for Federal Estate Tax

Elder Law Answers case summary.The Supreme Court holds that a company’s contractual obligation to purchase shares does not offset its value. In Connelly v. United States (U.S. No. 23–146, June 6, 2024).

Brothers Michael and Thomas Connelly were the sole shareholders in a small corporation, Crown C Supply. Michael owned approximately three-quarters of the shares, with 77.18 percent.

The brothers formed an agreement to keep the business in the family. The agreement stated that should one brother die, the survivor could purchase his shares. If the surviving brother did not choose to buy them, the company must acquire the shares. The company took out life insurance on both brothers for $3.5 million to fund the purchase.

After Michael passed away, the company purchased his shares for $3 million, using money from the life insurance policy. Michael and his brother’s son had agreed on $3 million without consulting an outside appraiser. As the executor of his brother’s estate, Thomas filed a tax return listing the value of Michael’s shares as $3 million.

The Internal Revenue Service (IRS) audited the return and disputed the value of the shares. During the audit, Thomas’ analyst appraised the company’s value at $3.86 million, which excluded the $3 million insurance proceeds. Finding the company worth $6.86 million, the IRS included the $3 million insurance proceeds in the valuation.

The IRS disagreed with the analyst’s valuation of Michael’s shares. To determine this value, both multiplied the company’s value by the percentage Michael owned. However, since the IRS appraised the company as worth more, Michael’s shares came out higher as well, increasing the tax on his estate. Compared to the analyst’s conclusion that Michael owned $3 million of the company, the IRS found he owned $5.3 million.

After paying the additional taxes, Michael’s estate sued the IRS for a refund. Granting summary judgment to the government, the district court held that the life insurance proceeds counted toward the value of Michael’s shares.

The Supreme Court granted certiorari to address whether life insurance proceeds that will redeem a decedent’s shares are included in the value of those shares for federal estate tax purposes.

In this case, the company’s contractual obligation to purchase shares did not offset its value. The life insurance money increased the value of Crown C Supply, which in turn increased the value of the deceased brother’s shares.

A fair-market-value redemption would not affect a shareholder’s economic interest in a company. A hypothetical buyer of Michael’s shares would get a 77.18 percent stake in a $6.86 million company and would pay up to $5.3 million.

To calculate estate tax, the court must look at the value of the shares at Michael’s death, which is based on the fair market value of the company. At Michael’s death, the company had not yet spent the $3 million to purchase his shares.

After purchasing shares, Crown’s value must be less. It cannot remain the same before and after the purchase.

The Supreme Court holds that a corporation’s contractual obligation to redeem shares is not necessarily a liability that reduces a corporation’s federal estate tax value. Because life insurance proceeds affect a company’s fair market value, they impact the value of company shares.

Read the full opinion.