The Connelly Decision “Easter Egg”

As seen in the Supreme Court's Connelly decision, the unanticipated reversal of what was thought to be settled law puts all stock redemption buy/sell agreements at risk of insurance proceeds being included in business valuation.

When the Supreme Court took up the Connelly case, virtually no one anticipated that the decision would have a far-reaching impact on buy/sell agreements and estate planning. The facts of the case were believed to be unique enough that they would serve as nothing more than a cautionary tale. The lack of periodic review and ongoing management of the agreement and funding rendered the Connelly family vulnerable upon audit. The prudent client and advisor could avoid the issue altogether by simply following best practices.

Unexpected Outcomes from the Decision

Ultimately, the decision did shine a light on the need to follow best practices, but it also included two additional results, similar to an “Easter Egg” in a movie, that have created quite a stir:

Based on the share of the business owned by the deceased (77.18%), the result was a significant increase in the taxable estate and estate taxes due for the Connelly family, as follows:

Remember, this outcome does not result from failing to follow best practices. This updated interpretation of the relevant law could be applied to virtually any stock redemption buy/sell agreement.

Key Considerations for Business Owners and Advisors

Some of the impacts of this decision on estate planning, buy/sell agreements, and beyond are relatively straightforward:

• Stock redemption plans involving clients with a net worth that could expose them to an estate tax will almost certainly need to be rewritten using a new structure that does not include the company as the insurance owner or beneficiary.
• An annual review of the agreement, including any periodic updated valuations and the like, needs to occur and be thoroughly documented.
• Funding of the agreement should likewise be updated as outlined in the agreement.

There are additional considerations outside the items listed above.

• The court’s view on including life insurance death benefits in the value of a business may have farther-reaching impacts that are now being considered by the planning community. These include but are not limited to:
  • The possible inclusion of other corporate-owned policies in business valuation calculations.
  • Impacts on business owner clients who are not subject to an estate tax.
• Funding strategies must keep pace with the business's value. Adhering to best practices requires considering both agreement structure and insurance product selection. Simply using the lowest-priced term insurance solution, for example, may no longer be the most suitable way to fund an agreement.

The Bottom Line: Time for a Review

Regardless of the business owner's net worth, it’s recommended to remove those old agreements and life insurance policies from the drawer where they have been gathering dust, with an eye toward keeping the family from becoming the next Connelly.

Navigating the impact of the Connelly decision requires expert guidance. Our team at LIFE Brokerage can help you review your buy/sell agreements, assess funding strategies, and ensure your business is protected. Schedule a meeting today to discuss your specific needs and safeguard your financial future.