Should a Redemption Funded by Life Insurance Increase Estate Tax Liability? The Supreme Court Will Decide.

The Supreme Court has just heard the oral arguments in Connelly v. Internal Revenue Service. In this case, Thomas Connelly had become the 100% sole shareholder of Crown C Supply Co. Inc. after his brother, who was 75% owner, passed away. Michael Connelly’s shares were redeemed by the company using life insurance money. The argument has come before the Supreme Court to decide if a redemption funded by life insurance money increases estate tax liability by increasing the value of ownership interest. At the heart of this debate is the true value of the redeemed shares. The IRS takes the position that the value of the company significantly increases as a third party would pay much more to buy all of the shares. On the other side, Michael’s estate argues that the life insurance money is required to be spent on the redemption and the estate is legally prohibited from selling its share to a third party. This means that the shares would never be able to be sold at the increased price the IRS has valued them at.

As the Supreme Court takes the necessary time to decide this case, succession and estate planners should prepare themselves for the outcome. This could cause small businesses and closely held corporations to completely rethink their succession plans, especially with the 2017 Tax Cuts and Jobs Act (TCJA) expiring in 2025. Preparations for the estate tax impact caused by transitioning ownership upon the death of a shareholder will rely heavily on the outcome of this case.