Tax court case: how a buy-sell agreement can raise your estate tax

The short answer: if your company owns life insurance to buy back a deceased owner’s shares, the insurance payout can make those shares worth more for estate tax, not less. That is what the U.S. Supreme Court decided in Connelly v. United States, No. 23-146, 602 U.S. 257, decided June 6, 2024. The vote was unanimous. For owners whose estates may be large enough to owe federal estate tax, the case is a reason to pull out the buy-sell agreement and read it again.

What happened

Two brothers, Michael and Thomas Connelly, were the only shareholders of Crown C Supply, a building supply company in St. Louis, Missouri. Michael owned 77.18% of the shares and Thomas owned 22.82%. Like many family business owners, they signed an agreement to keep the company in the family if one of them died.

Under the agreement, the surviving brother had the first option to buy the deceased brother’s shares. If he declined, the company itself had to buy them back (a redemption). The agreement called for the price to be based on an outside appraisal. To make sure the company would have the cash, Crown bought $3.5 million of life insurance on each brother.

Michael died in 2013. Thomas chose not to buy the shares, so Crown had to redeem them. Instead of getting the outside appraisal the agreement described, Thomas and Michael’s son agreed the shares were worth $3 million, and Crown paid that amount to the estate using the insurance proceeds. The estate tax return reported Michael’s shares at $3 million.

What the IRS argued

The IRS audited the estate tax return. An accounting firm hired during the audit valued Crown at $3.86 million, leaving out the $3 million of insurance money on the theory that the duty to pay it to the estate canceled it out. At 77.18%, that put Michael’s shares at about $3 million.

The IRS disagreed. It counted the insurance proceeds as a company asset, valued Crown at $6.86 million ($3.86 million plus $3 million), and valued Michael’s shares at $5.3 million. That produced an additional $889,914 in estate tax. The estate paid it and sued for a refund. The federal district court in Missouri ruled for the government, and the Eighth Circuit Court of Appeals affirmed.

What the Supreme Court decided, and why

Justice Thomas wrote the opinion for a unanimous Court. Everyone agreed that life insurance payable to a company is an asset that increases the company’s value. The only question was whether the company’s promise to buy back the shares was a debt that offset that asset. The Court said no.

The reasoning comes down to timing and the “willing buyer” test. For estate tax, shares are valued at their fair market value at the moment of death: the price a willing buyer would pay a willing seller, both knowing the relevant facts. At Michael’s death, Crown held the $3 million of insurance money plus $3.86 million of other value. A buyer of Michael’s 77.18% stake would expect to be paid fair market value for those shares in the redemption, so the buyer would pay up to $5.3 million. A buyback at fair market value doesn’t change any owner’s economic position; it simply converts shares into cash. As the Court put it, the point of the estate tax is to value the shares “at the time that he died,” before the company spent the money.

The estate also argued that the ruling makes succession planning harder, because a company would need much more insurance to fund a buyback at the higher value. The Court agreed that was true, but said it was “a consequence of how the Connelly brothers chose to structure their agreement.” It noted that a cross-purchase agreement, where the owners buy policies on each other and buy each other’s shares, would have sent the proceeds to Thomas instead of the company. It also noted that a cross-purchase has its own drawbacks: each owner must keep paying premiums on the other, and the arrangement has its own tax consequences.

The Court was careful to keep its holding narrow. It did not say a redemption obligation can never reduce a company’s value. A buyback that forces a company to sell operating assets could reduce its future earning power. It simply rejected the idea that every redemption obligation is a liability that cancels out the insurance.

Lessons for business owners

The Connelly family did what many owners are told to do: they signed an agreement and funded it with insurance. The lesson is not that buy-sell agreements are a bad idea. It’s that the details decide the tax result.

• Know which kind of agreement you have. Many agreements are redemption agreements (the company buys), cross-purchase agreements (the other owners buy), or a mix like the Connellys’. Who owns the policies and who collects the proceeds matters for estate tax valuation.
• Check the coverage against the real value. If the company owns the policies, the insurance itself can raise the value of the shares it is meant to buy. Coverage that looked right when the agreement was signed may fall short of a fair market value buyout today.
• Follow the agreement’s pricing method. The Connelly agreement called for an outside appraisal, but the family agreed on a price instead. The Court noted that the price set in an agreement is ordinarily not controlling for estate tax; fair market value is. A current, independent valuation helps everyone, including the IRS, see the same numbers.
• Weigh the trade-offs of a change. Moving to a cross-purchase or another structure can change who pays premiums, how many policies are needed, and the income tax results. Those changes belong in a conversation with your estate attorney, insurance advisor, and tax strategist together.
• Revisit the plan as the business grows. For 2026, each person can pass $15 million free of federal estate and gift tax under the 2025 tax law, and married couples can shelter up to $30 million with portability. Many owners will fall under those amounts, but a valuable company plus real estate, investments, and insurance can add up quickly, and the exemption is applied to the full fair market value of the business interest.

If you are also thinking about moving some of the business to the next generation during your life, our strategy pages on lifetime gifts and SLATs and family limited partnerships explain how owners use their exemption now so future growth stays outside the estate. Both depend on solid valuations, the same issue at the heart of Connelly.

How we help

At Cannon & Brown Tax Advisors, we review buy-sell agreements, entity structure, and estate tax exposure as part of the tax plan, and we work alongside your estate attorney and insurance advisor so the pieces fit together. Your tax strategist reviews every recommendation. If you’d like to see how your current agreement and estate picture look, start with a free tax analysis.

This article is educational and is not tax advice for your situation. Tax law may change, which may change these rules and numbers.

Sources

• Supreme Court of the United States: Connelly v. United States, 602 U.S. 257 (2024), No. 23-146
• IRS: Estate tax
• IRS: What’s new, estate and gift tax
• IRS: Revenue Procedure 2025-32 (2026 inflation adjustments)
• Cornell LII: 26 CFR 20.2031-2, Valuation of stocks and bonds
• Cornell LII: 26 U.S.C. 2703, Certain rights and restrictions disregarded