Estate Planning for a Family Business usually includes an insured buyout. Since 2024, a policy the company owns counts toward the value of the very shares it was bought to purchase.
The policy bought to pay for the shares can make the shares worth more, and the estate is taxed on the larger number.
A common buy-sell design works like this: the company owns a life insurance policy on each owner, and when an owner dies the company uses the proceeds to redeem that owner's shares from the family. For years many owners and advisers assumed the proceeds and the duty to redeem offset each other, so the insurance added nothing to the value of the shares. On June 6, 2024, in Connelly v. United States, 602 U.S. 257, a unanimous Supreme Court held that they do not.
The ruling matters most to an estate large enough to owe federal estate tax. The reason the family lost matters to every owner whose agreement names a price nobody has updated.
What happened. Michael and Thomas Connelly were brothers and the only shareholders of Crown C Supply, a building supply company. Michael owned 77.18 percent. Their agreement gave the surviving brother the option to buy the other's shares and, if he declined, required the company to redeem them. The company carried $3.5 million of life insurance on each brother for that purpose. Michael died in 2013, Thomas declined to buy, and the company redeemed the shares for $3 million, a figure Thomas and Michael's son agreed on. The estate reported the shares at $3 million. The Internal Revenue Service counted the $3 million of proceeds used for the redemption as a company asset, valued the company at $6.86 million and Michael's shares at about $5.3 million, and assessed $889,914 in additional estate tax.
Why the offset failed. The Court reasoned that a redemption at fair market value does not change any shareholder's economic interest: the company pays out cash and retires shares of equal value. Someone buying Michael's 77.18 percent at the moment of his death would be buying that share of a company holding the insurance proceeds. The obligation to redeem was therefore not a liability that reduced the value of the shares. The opinion notes that it does not hold a redemption obligation can never reduce a company's value.
The price was never fixed. The agreement called for the brothers to sign a certificate of agreed value each year, with appraisals as the fallback. They never signed one, and no appraisal was obtained after Michael died. Internal Revenue Code section 2703 disregards a buy-sell price for estate tax purposes unless the agreement is a bona fide business arrangement, is not a device to pass property to family for less than full consideration, and has terms comparable to an arm's-length deal. A pricing mechanism the owners themselves did not follow gives the estate very little to stand on.
The alternative the Court named. In a cross-purchase agreement the owners hold policies on each other and buy the shares personally, so the proceeds never pass through the company. The buyer also takes a cost basis in the shares purchased. The Court acknowledged the drawbacks: each owner pays premiums on the others, and the policy count grows quickly. Two owners need two policies. Four owners need twelve.
The obvious response is to move the existing policies from the company to the owners. That can create a different tax problem. Under Internal Revenue Code section 101(a)(2), a policy transferred for value loses most of its income tax exclusion unless the transfer is to the insured, to a partner of the insured, to a partnership in which the insured is a partner, or to a corporation in which the insured is a shareholder or officer. A fellow shareholder is not on that list. Policies that stay with the company carry their own condition: section 101(j) limits the tax-free proceeds of an employer-owned policy issued after August 17, 2006 to the premiums paid, unless written notice and consent were obtained before the policy was issued and a statutory exception applies. The company reports those policies each year on Form 8925.
Scale matters too. For 2026 the federal basic exclusion amount is $15 million per person, and California imposes no estate tax of its own, so many family companies will never owe the tax Connelly measured. For them a redemption funded by company-owned insurance may still be the better design: one set of policies, premiums paid by the company, and no owner writing a personal check for a co-owner's coverage. The valuation problem does not depend on the tax at all. A price set once and never revisited decides what a family is actually paid, whether or not a return is ever filed.
Estate Planning for a Family Business means reading the buy-sell agreement, the policies and the trust as one document set. The trust says who receives the shares. The agreement says what they turn into, and at what price. If the two were drafted years apart by different people, they may not describe the same outcome.
General information about federal and California law, not legal advice, and no attorney-client relationship is created. How these rules apply depends on your entity type, your agreement, your policies and the size of your estate.
Bring the buy-sell agreement and the policy statements. We will tell you who owns what, and what price the family would be paid today.
