Connelly v. United States and What It Means for Buy-Sell Life Insurance

When a company owns life insurance on its owners to buy out the first to die, the insurance money counts toward the company's value for the dead owner's estate tax, even though every dollar of it is promised to the estate. That is what a unanimous Supreme Court decided in Connelly v. United States in June 2024, and for one family it meant $889,914 of additional federal estate tax on a $3 million buyout.

The decision matters most to owners whose estates may owe federal estate tax: the basic exclusion is $15 million a person for 2026 (IRS), and some states tax estates well below that. It also matters to anyone whose agreement sets a buyout price from the company's value, because the same insurance money can change that number. What follows is the case as the opinion tells it, the arithmetic, and what an owner with a redemption agreement funded by company-owned insurance should take to a lawyer. The general case for these agreements is in Buy-Sell Agreements for Business Partners; this page is about one decision. It is general information, and a lawyer and tax adviser in the owners' state should read the actual agreement.

Michael and Thomas Connelly were the only shareholders of Crown C Supply, a building supply company in St. Louis. Michael owned 77.18% (385.9 of 500 shares) and Thomas 22.82%. Their agreement gave the surviving brother the option to buy the deceased brother's shares; if he declined, Crown itself had to redeem them, at a price based on an outside appraisal of Crown's fair market value. To make sure Crown could pay, it bought $3.5 million of life insurance on each brother.

For estate tax, shares in a closely held company are valued at what a willing buyer would pay, and the Treasury regulations say the company's value includes 'proceeds of life insurance policies payable to' it. The estate's argument was that the duty to redeem Michael's shares was a liability that cancelled out the insurance, so the two should be left out together. The Court rejected that because paying a shareholder fair value for his shares does not change what anyone else's shares are worth.

The Court also dealt with the estate's claim that Crown was worth $3.86 million both before and after the redemption. A company that pays out $3 million to buy back shares has to be worth less afterward than before, so both figures could not be right, and the one that mattered for the estate tax was the value at the moment of death, before the payment.

The agreement called for an outside appraisal. The family instead agreed on $3 million 'in an amicable and expeditious manner', in the opinion's words, and the estate reported that figure. The opinion notes in passing that a price set in an agreement 'is ordinarily not dispositive' for estate tax, citing 26 U.S.C. § 2703, which disregards a below-market purchase right unless it is a bona fide business arrangement, is not a device to pass property to family for less than full value, and has terms comparable to an arm's length deal. A price nobody tested against the agreement's own method is an easy one for the IRS to set aside.

The practical lesson is separate from the insurance question. If an agreement says an appraiser sets the price, use the appraiser, and keep the report. How the appraisal itself works is covered in How to Value a Business Partner's Share.

The opinion itself names the main alternative. In a cross-purchase agreement the owners buy insurance on each other and buy the deceased owner's shares personally, so the proceeds go to the surviving owner, not the company, and never raise the company's value. The Court was candid about its costs: each owner pays the premiums on the others, which creates the risk that one cannot, and it 'would have had its own tax consequences.' With more than two owners the number of policies grows quickly, which is why some planners use an entity or trust that holds one policy per owner on the owners' behalf; Connelly does not address those arrangements, so their tax treatment is a question for an adviser.

The case was about a C corporation's stock. It did not decide how a partnership or LLC interest bought out under the partnership tax rules should be valued when the buyout is funded the same way. The valuation reasoning, that a fair-value redemption leaves the remaining owners no better or worse off, does not depend on the entity being a corporation, which is why many advisers treat it as reaching partnerships and LLCs too; until a court applies it to one, that is a reasonable reading, not a holding. The steps a family faces after a death, with or without an agreement, are in What Happens When a Business Partner Dies, and Connelly sits among 19 other court decisions in Business Partnership Dispute Cases.

The brothers wanted the company to stay in the family and the money to be there when one of them died, and their agreement did both. What it did not do was decide who should own the insurance, and that choice cost the estate more than a quarter of the buyout price in tax.