The U.S. Supreme Court recently issued a unanimous opinion in Connelly v. Internal Revenue Service. This ruling resolves a common estate tax issue for corporate shareholders in favor of the IRS. The high Court’s decision creates various estate planning opportunities to avoid placing an increased estate tax burden on the owners of closely held corporations.
Closely held or family corporations routinely buy life insurance policies insuring the life of the principal corporate shareholders. When a corporate shareholder passes away, the life insurance policy proceeds allow the corporation to purchase the shareholder’s shares to keep control of the corporation within the original family.
However, the issue this situation creates is how those life insurance policy proceeds impact the corporation’s value when they flow into the corporation just after the shareholder’s death. From one perspective, the insurance proceeds increase the corporation’s value as money that the corporation holds. From another perspective, the corporation should stay at the same value, as the corporation immediately spends the insurance proceeds to purchase the deceased shareholder’s shares.
In the Connelly case, brothers Michael and Thomas Connelly were the sole shareholders of Crown C Supply, a building supply corporation. Michael owned about 75% of the corporation’s shares, and Thomas owned about 25% of the corporation’s shares. The brothers had a buy-sell agreement stating that the surviving brother could purchase the deceased brother’s shares if either brother passed away. If the surviving brother declined to do so, the corporation had to redeem the shares using life insurance proceeds from a policy covering the deceased brother’s life.
Michael passed away, and Thomas declined to purchase his shares. Therefore, the corporation used the $3 million in life insurance proceeds to redeem Michael’s shares.
At the time of Michael’s death, the corporation was worth about $4 million as an operating business. The corporation reported that Michael’s shares were worth about $3 million, or 75% of $4 million. However, the IRS took the position that the corporation was now worth $7 million due to the influx of insurance policy proceeds, which made Michael’s shares worth about $5.3 million (75% of $7million). The IRS’s valuation figures substantially increased the estate tax liability.
The Supreme Court affirmed the decisions of the District Court and Eighth Circuit, siding with the IRS. The Court found that “an obligation to redeem shares at fair market value does not offset the value of life insurance proceeds.” The Court further reasoned that “[b]ecause a fair-market value redemption does not affect any shareholder’s economic interest no willing buyer would have treated [the] obligation to redeem … as a factor that reduced the value of those shares.” Since the corporation chose a structure by which life insurance policy proceeds would pay out to the corporation upon a shareholder’s death, the deceased shareholder must be taxed on the increased value of the corporation.
Although the Court acknowledged that its decision could make succession planning for closely held corporations more complex, various planning techniques and transactional devices can avoid this result. Every planning device and structure has benefits and tax consequences. Closely held corporations must weigh those pros and cons with the benefit of experienced legal counsel and determine the best approach based on their unique circumstances.
A Hallandale Beach estate planning attorney at Kramer Green can help you create a comprehensive estate plan that serves your needs. We can help you determine your objectives and how to meet those goals during the estate planning process, as well as address any estate tax issues that may exist. We can determine the best course of action for you and your family.
Look to Kramer Green for Advice about Your Estate Tax Matter
A Hallandale Beach estate planning lawyer at Kramer, Green, Zuckerman, Greene & Buchsbaum, P.A. can assist you with all aspects of your estate plan, including estate tax issues. We know how to structure your estate plan to preserve assets and handle complex probate and estate issues. We have the skills and experience to help you carry out your wishes for your estate.
Our objective is to guide you through the complex legal estate planning process. Contact our office today at (954) 966-2112 or online to schedule a time to discuss your estate planning issues with our Hallandale Beach estate planning attorney.