Supreme Court Considers Case on Estate Insurance Tax Treatment

The U.S. Supreme Court could soon rule on a case that would significantly impact succession plans for closely held businesses and put those plans at risk for higher taxes, as reported in a recent article from Bloomberg Tax, “High Court Signals Doubt Over Estate Insurance Tax Treatment.”

Thomas Connelly and his brother created a buy-sell agreement for their family business, Crown C Supply Co. In the agreement, whichever brother survived the other had the option to buy the other’s stock or required Crown to redeem the stock, using proceeds from the company's life insurance policies for both brothers. Michael passed away, and his brother followed the terms of the agreement.

The IRS’s position is that Michael’s redeemed stock is worth more than reported, since the company’s value increased when it received the insurance proceeds. According to the IRS, Michael’s redeemed 77% equity interest was valued at $5.3 million. The estate had reported a value of $2.3 million less, since it did not include the value of the insurance proceeds.

Thomas claims the company’s net worth did not increase because the insurance proceeds were offset by the agreement to redeem his brother’s shares.

An assistant to the Solicitor General asked the Court to distinguish between an obligation to outside creditors and the value to an equity interest holder. Redemption gives one shareholder cash in exchange for their assets, while the other is to maintain control of the company.

To date, at least three Circuit Courts have addressed the issue of whether life insurance proceeds used for a stock exemption increase the company’s value. Unfortunately, they don’t all agree. In legal circles, the expression is “Courts are split.”

For business owners with buy-sell agreements incorporating insurance policies, this decision could have significant ramifications for their estate plan. What had been a relatively straightforward estate planning tool may not be allowed after the Supreme Court releases its decision.

Should the Court rule against the estate, there are several alternative planning options. An experienced estate planning attorney can guide privately held businesses in structuring and funding their buy-sell agreements.

Reference: Bloomberg Tax (March 27, 2024) “High Court Signals Doubt Over Estate Insurance Tax Treatment”