In 2024, new tax consequences are significantly impacting the use of life insurance in succession planning. The recent ruling in Connelly v. United States has reshaped how closely held businesses navigate estate taxes when using life insurance to fund buy-sell agreements (BSAs). Traditionally, life insurance proceeds used to buy out a deceased owner’s shares were excluded from the valuation of the estate, helping reduce tax burdens for surviving owners. However, the U.S. Supreme Court has now shifted this approach, ruling that life insurance proceeds increase the value of the business for estate tax purposes despite any redemption obligations tied to the buyout.
This ruling introduces new challenges for business owners who rely on insurance-funded BSAs. The central issue stems from how the IRS values life insurance proceeds. In the Connelly case, the IRS argued – and the Court agreed – that the proceeds received by the company to buy out a deceased shareholder should be added to the company’s value for estate tax purposes. Consequently, this pushes up the estate tax liability for the deceased’s estate — even though the life insurance money is earmarked for the buyout. Previously, these proceeds were seen as a neutral transaction, but now they directly inflate the taxable estate’s value, complicating succession plans for many family-owned and closely held businesses.
This change demands a recalibration of tax planning strategies. Business owners must now consider alternative ways to structure life insurance policies or rethink how they execute BSAs. For instance, cross-purchase agreements, where individual owners hold policies on each other instead of the company, may mitigate some tax impacts. Additionally, other structures like irrevocable life insurance trusts (ILITs) may help shield life insurance proceeds from estate tax valuations, depending on the specifics of the ownership and beneficiary designations.
Another critical concern involves the scheduled reduction of the federal estate tax exemption in 2026, which will only heighten the consequences of this ruling for high-net-worth individuals. As the exemption amount shrinks, more estates will fall under taxable thresholds, amplifying the need to scrutinize BSAs and life insurance’s role in succession strategies. Estate planners must work closely with legal and tax advisors to ensure their strategies remain tax-efficient, especially as further legislative changes could emerge.
The Supreme Court’s ruling highlights the importance of staying ahead of regulatory shifts and ensuring that life insurance strategies do not inadvertently increase estate tax liabilities, undermining the very goals of succession planning. As the tax landscape grows and changes, proactive restructuring will be essential in maintaining the effectiveness of life insurance in preserving business continuity across generations – Appraisal Economics is here to assist with required qualified valuations.