United States Supreme Court Unanimously Decides that Life Insurance Proceeds on Life of Business Owner Increases Value of Shares
Connelly v. United States, 144 S.Ct. 1406 (2024)
Two brothers, Michael and Thomas Connelly, owned a building supply corporation. To keep the company in the family in the event either of the brothers died, the brothers entered into an agreement where the surviving brother would have the option to purchase the deceased brother’s shares. If the surviving brother declined to purchase the deceased brother’s shares, then the corporation would be required to purchase the deceased brother’s shares.
To ensure that the corporation had the necessary funds to purchase a deceased brother’s shares, the corporation obtained $3.5 million in life insurance on each brother.
Upon Michael’s death, Thomas chose not to purchase Michael’s shares. As a result, the corporation was required to do so using the proceeds of the life insurance policy the corporation took out on Michael’s life. Instead of obtaining an independent appraisal of the fair market value of the corporation as the agreement required, Michael’s son and Thomas agreed that the value of Michael’s shares was $3 million. As the Executor of Michael’s estate, Thomas then reported that value on the federal tax return for the estate.
On audit, the IRS disagreed with the estate over how to value Michael’s shares for the purposes of calculating the federal estate tax.
The IRS argued that the life insurance proceeds intended for purchasing Michael’s shares needed to be included with the value of Michael’s shares to calculate the total fair market value of Michael’s interest in the corporation. Thomas argued that the life insurance proceeds intended for purchasing Michael’s shares did not need to be included in calculating the total fair market value of Michael’s shares in the corporation. Ultimately, the IRS included the $3 million in life-insurance proceeds in valuing Michael’s shares and determined that the estate owed an additional $889,914 in taxes. Michael’s estate paid the deficiency, and Thomas brought an action seeking a refund from the IRS in his capacity as Executor.
The Eastern District of Missouri granted summary judgement for the IRS. Thomas appealed. The United States Court of Appeals for the Eight Circuit affirmed the lower court’s decision.
The United States Supreme Court granted certiorari to address whether the corporation’s obligation to redeem Michael’s shares was a liability that decreased the value of those shares. In a unanimous opinion, the Supreme Court held that the corporation’s contractual obligation to use life insurance proceeds to redeem shares at fair market value was not a liability that reduced the value of shares, and therefore the value of the proceeds had to be included in valuing Michael’s interest in the corporation for purposes of the federal estate tax. In issuing this opinion, the Supreme Court overturned Estate of Blount v. Commissioner 428 F.3d 1338 (11th Cir. 2005), which held that insurance proceeds do not need to be added to value of corporation.