Wealth management and financial planning; for individuals and businesses.
Supreme Court Ruling on Buy-Sell Agreements – What Business Owners Need to Know

by Meritrust Wealth Advisors

Key Points:
  • Impact on Business Valuation: Life insurance proceeds must be included in the business valuation for estate taxes.
  • Potential for Higher Estate Taxes: This could push estates over the exemption limit, increasing tax liabilities.
  • Liquidity Concerns: Without proper planning, businesses may face liquidity challenges when covering estate taxes.
  • Alternatives Available: Different buy-sell structures can help avoid these issues.
As a business owner, planning for the future involves many complex decisions, especially when it comes to protecting the value of your business and ensuring a smooth transition in the event of an owner’s death. The recent Supreme Court decision in Connelly v. United States has introduced significant changes that could affect your estate planning, particularly if your business relies on an entity-purchased buy-sell agreement.

Understanding the Supreme Court's Decision

The ruling centers on how life insurance proceeds are treated within entity-purchased buy-sell agreements for estate tax purposes. The Supreme Court has ruled that these proceeds must be included in the business’s valuation within the deceased owner’s estate. However, the repurchase obligation—essentially the cost the business incurs to buy back the shares—cannot be used as an offset against the fair market value (FMV) of the business.

This change could result in a higher valuation of your business, potentially increasing the estate's value and leading to larger estate tax liabilities.

What Does This Mean for You?

As a business owner, you might now face a situation where your estate's value is inflated due to the inclusion of life insurance proceeds, pushing you over the current estate tax exemption limit. This could result in a significant increase in the taxes owed upon your passing, creating challenges for your heirs and possibly requiring them to sell business assets to cover these taxes.

Liquidity Issues: This ruling could also introduce liquidity challenges. Without additional life insurance or proper planning, your estate might struggle to cover the increased tax liability, putting the future of your business at risk.

How to Protect Your Business

Thankfully, there are strategies available to mitigate these potential issues:
  • Cross-Purchase Buy-Sell Agreements: In this structure, each business owner holds a life insurance policy on the other owners, allowing the proceeds to bypass the business entirely. This structure can help avoid inflating the business’s valuation.
  • Cross-Endorsement Structures: This approach reduces complexity by allowing each business owner to endorse their life insurance policy’s death benefit to the other owners, simplifying administration while avoiding the estate tax impact.
  • Insurance LLC: Forming an LLC to own the life insurance policies can centralize and streamline policy management, although this requires careful structuring to ensure it avoids the same tax implications as entity-purchase agreements.
  • Trusteed Buy-Sell Agreements: By placing the life insurance policies under the control of a trustee, the proceeds can be used to facilitate the buyout without increasing the business's estate valuation.
Next Steps

If your business has a buy-sell agreement in place, now is the time to review it with your financial advisor and legal counsel. Ensuring that your planning is up-to-date and compliant with the latest legal developments is crucial to protecting your business’s future.

We’re here to help you navigate these changes and find the best solutions for your unique situation.

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