Buy-Sell Agreements Are Dead! (Just Kidding!)

On Thursday, June 6th, something extraordinarily rare happened. The United States Supreme Court issued an opinion in a case that impacts business and estate planning and life insurance. Specifically, the opinion concerned the use of life insurance to fund a specific type of buy-sell arrangement and may impact the existing and future planning of a number of closely held private businesses.

Let’s take a quick look at the decision and its holding before diving into its implications and recommendations on the path forward.

Divided Court? Not Here!

The case in question is Estate of Connelly v. United States and involved a C-corporation owned by two brothers that had a buy-sell agreement in place. The agreement stipulated that upon the death of one brother, the corporation itself would redeem the deceased brother's shares at fair market value if the surviving brother chose not to redeem the shares himself. The company purchased life insurance policies on each brother to fund this redemption obligation.

One brother died triggering the provision. The surviving brother chose not to redeem the shares, leaving the corporation itself obligated to do so via the funds received from the applicable life insurance policy. At issue was whether the life insurance proceeds received by the corporation increased the fair market value of the corporation without an offsetting liability arising from the company’s obligation to purchase the deceased shareholder’s shares.

In a 9-0 decision, the Court found, “a corporation’s contractual obligation to redeem shares is not necessarily a liability that reduces a corporation’s value for purposes of the federal estate tax.” Therefore, for estate tax purposes, the fair market value of the corporation had to include the value of those life insurance proceeds received without the ability to reduce that valuation by the amount of the redemption obligation.

For companies with similar structures and agreements in place, this could cause estate taxation issues - especially with the looming sunset of the current federal gift and estate tax exemption amount at the end of 2025. Furthermore, the life insurance acquired to fund the redemption obligation may not be an insufficient amount as the value of the company will be greater than previously expected, requiring more cash to fund such a redemption.

Are All Buy-Sells are Impacted?

No. The Court notes in its opinion that the parties in Connelly could have pursued a cross purchase arrangement and avoided the issue around a valuation increase. In these buy-sell arrangements, the redemption obligation falls to the shareholders and not the company, and each shareholder obtains the necessary life insurance on the other shareholders.

As the Court notes, while this type of arrangement avoids the valuation issue, it does raise other issues for the parties. Namely, in this style of arrangement, the shareholders, not the company, pays for the life insurance. Furthermore, issues arise around ensuring that all the shareholders maintain the life insurance necessary to fund this arrangement and do not let the policies lapse. Finally, there may be tax consequences to this arrangement.

What Do I (or my clients) Do?

It is important for closely held companies to have buy-sell agreements in place and to ensure that any obligations that arise from such agreements are funded. With this in mind, here are the action items the owner of every closely held company should consider:

1. If you have a buy-sell agreement in place, reach out to your advisors (or us) to see if it should be repositioned.
   

2. If you have a buy-sell but it’s not funded, reach out to your advisors (or us) to help evaluate the best ways to deal with the liability – which could very well simply be life insurance.
   

3. If you don’t have a buy-sell but own a company, let us work with you to determine the best way to handle a buy-sell arrangement. Remember, a buy-sell could be between business partners, family members taking over the business, and even trusts for personal estate planning.
   

4. If you haven’t gotten a valuation yet, do so! They help set the stage for buy-sell arrangements and ensure that the liability is fully covered. If you need introductions to valuation specialists, we can help.

We Can Help

For shareholders in closely held companies, buy-sell agreements are an incredibly important piece of the planning puzzle for both the company and their own personal planning as well. Ensuring that the agreement and funding mechanism are aligned and working properly, as well as understanding how that impacts personal estate planning, is essential.

At Robin Glen, we use our expertise in income and estate tax, private capital, and insurance analysis and design to create unique solutions that deliver impactful results for our clients and advisor partners. We can work with your team of advisors so that you have the peace of mind to know you, your company, your family, and your fellow shareholders are all taken care of.