Does life insurance owned by a company increase the estate tax value of the owner’s shares?
Ordinarily yes, and the instruction is older than the case now cited for it. Treasury Regulation § 20.2031-2(f) governs the valuation of closely held stock where the preceding paragraphs are inapplicable “because actual sale prices and bona fide bid and asked prices are lacking,” and provides that “consideration shall also be given to nonoperating assets, including proceeds of life insurance policies payable to or for the benefit of the company, to the extent such nonoperating assets have not been taken into account in the determination of net worth, prospective earning power and dividend-earning capacity.” That sentence sits in the undesignated text following subparagraph (2), which is why both the Supreme Court and the Eighth Circuit cite it as § 20.2031-2(f)(2). Proceeds payable to the company are an asset of the company, and the value of a decedent’s shares is computed from what the company is worth.
Connelly v. United States, No. 23-146 (U.S. 6 June 2024), settled the question that had been fought over instead. Michael and Thomas Connelly were the only shareholders of Crown C Supply, a building supply corporation; Michael held 77.18% and Thomas 22.82%. Their agreement gave the surviving brother the option to purchase the deceased brother’s shares and, if he declined, required Crown itself to redeem them — and Crown obtained $3.5 million of life insurance on each brother so that it would have the money if the redemption were triggered. A unanimous Supreme Court recorded that the basic point was common ground — “all agree that life-insurance proceeds payable to a corporation are an asset that increases the corporation’s fair market value” — and that the only contested question was whether Crown’s obligation to redeem Michael Connelly’s shares offset the proceeds committed to funding that redemption. The Court held it did not. This is federal transfer tax rather than state fair value law: the standard comes from the Internal Revenue Code and the Treasury regulations, and a Supreme Court holding on it binds every court in the country.
Life-insurance proceeds payable to the company are not counted twice, and the regulations say so. Treasury Regulation § 20.2042-1(c)(6) provides that where the economic benefits of a policy on the decedent’s life are reserved to a corporation of which the decedent is the sole or controlling stockholder, the corporation’s incidents of ownership are not attributed to the decedent through his stock ownership “to the extent the proceeds of the policy are payable to the corporation,” and the same paragraph points the reader to § 20.2031-2(f) for the rule that those proceeds are instead considered in valuing the decedent’s stock. Where part of the proceeds is payable to someone other than the corporation — the regulation’s own example is a policy payable to the decedent’s spouse — the corporation’s incidents of ownership are attributed to a controlling shareholder and that part is included in the gross estate under IRC § 2042. The regulation treats a decedent as a controlling stockholder only where, at death, he owned stock possessing more than 50 percent of the total combined voting power of the corporation.
Why didn’t the company’s obligation to buy back the shares cancel out the insurance proceeds?
Because a redemption at fair market value does not change any shareholder’s economic interest, so a buyer would not price it as a liability. That is the whole of the Supreme Court’s reasoning in Connelly v. United States: “An obligation to redeem shares at fair market value does not offset the value of life-insurance proceeds set aside for the redemption because a share redemption at fair market value does not affect any shareholder’s economic interest.” The Court proved it with arithmetic — a corporation whose only asset is $10 million in cash, with shareholders A and B holding 80 and 20 of its 100 shares; paying B $2 million to redeem B’s shares leaves A holding 80 shares in a company worth $8 million, and A’s shares are still worth $100,000 each. On the facts before it the Court concluded that “no willing buyer purchasing Michael’s shares would have treated Crown’s obligation to redeem Michael’s shares at fair market value as a factor that reduced the value of those shares.”
Timing does the rest of the work. The estate tax measures the decedent’s property at death, and IRC § 2033 defines the gross estate to “include the value of all property to the extent of the interest therein of the decedent at the time of his death,” which the Supreme Court in Connelly v. United States read to mean that “the whole point is to assess how much Michael’s shares were worth at the time that he died—before Crown spent $3 million on the redemption payment.” The Court also found the estate’s position internally inconsistent, since it valued Crown C Supply at $3.86 million both before and after a $3 million redemption: “A corporation that pays out $3 million to redeem shares should be worth less than before the redemption.” On the Internal Revenue Service’s figures Crown was worth $6.86 million at the date of death, Michael Connelly’s 77.18% interest was worth $5.3 million rather than the $3 million reported, and the deficiency was $889,914. The estate and gift valuation subject area sets out the date rules the computation runs on.
Anyone working from a memorandum written before June 2024 is working from a different rule. The Eleventh Circuit had reasoned the other way in Estate of Blount v. Commissioner, 428 F.3d 1338 (11th Cir. 2005), concluding that insurance proceeds should be deducted from the value of a corporation where they are offset by an obligation to pay those proceeds to the estate in a stock buyout; the Eighth Circuit noted that Blount had cited favorably the similar reasoning of Estate of Cartwright v. Commissioner, 183 F.3d 1034 (9th Cir. 1999). In Connelly v. Department of Treasury, IRS, 70 F.4th 412 (8th Cir. 2023), the Eighth Circuit declined to follow Blount, holding that “Blount’s flaw lies in its premise” because an obligation to redeem shares “is not a liability in the ordinary business sense,” and it tested the estate’s theory against the surviving brother’s position: on the estate’s own figures each Crown share would have been worth $7,720 immediately before the redemption and the surviving brother’s shares about $33,800 each immediately after, so that “[o]vernight and without any material change to the company, Thomas’s shares would have quadrupled in value.” The Supreme Court affirmed that judgment. It did not expressly overrule Blount, and cites it only as the source of the assumption the estate’s analyst took as given and of the position the Court rejected.
Does Connelly mean a redemption obligation can never reduce a company’s value?
No, and the Supreme Court said so in a footnote that is doing a great deal of work. Footnote 2 of Connelly v. United States reads in full: “We do not hold that a redemption obligation can never decrease a corporation’s value. A redemption obligation could, for instance, require a corporation to liquidate operating assets to pay for the shares, thereby decreasing its future earning capacity. We simply reject Thomas’s position that all redemption obligations reduce a corporation’s net value. Because that is all this case requires, we decide no more.” The holding is phrased to match: “Because redemption obligations are not necessarily liabilities that reduce a corporation’s value for purposes of the federal estate tax, we affirm the judgment of the Court of Appeals.”
Two limits follow from the way the Connelly opinion is written. The first is the price term: what Connelly v. United States decides is that an obligation to redeem at fair market value is not an offsetting liability, and the reasoning turns on the fact that a fair-market-value redemption leaves every shareholder’s economic interest where it was. The second is the reservation in footnote 2, which identifies a mechanism rather than announcing a rule — an obligation that forces the corporation to liquidate operating assets, reducing its future earning capacity — and leaves that to be established on evidence in some later case. Neither limit is a discount, and the Business Valuation Institute does not supply one: what a particular redemption obligation does to a particular company’s earning capacity is a question of fact on the record in that matter.
The Eighth Circuit’s ground for affirming in Connelly v. Department of Treasury, IRS, 70 F.4th 412 (8th Cir. 2023), is narrower still and worth keeping separate. It held that an obligation to redeem shares “is not a liability in the ordinary business sense,” citing Fletcher Cyclopedia of the Law of Corporations for the proposition that “[t]he redemption of stock is a reduction of surplus, not the satisfaction of a liability.” That is a statement about corporate-law mechanics rather than about insurance policies, and it is the premise the whole result rests on: if the redemption obligation is not a liability, there is nothing for the insurance proceeds to be netted against.
Would a cross-purchase agreement have kept the proceeds out of the valuation?
On the facts of Connelly v. United States the Supreme Court said it would have, and said why. Answering the argument that its decision would make succession planning harder for closely held corporations, the Court observed that the Connelly brothers “could have used a cross-purchase agreement—an arrangement in which shareholders agree to purchase each other’s shares at death and purchase life-insurance policies on each other to fund the agreement,” and that such an agreement “would have allowed Thomas to purchase Michael’s shares and keep Crown in the family, while avoiding the risk that the insurance proceeds would increase the value of Michael’s shares. The proceeds would have gone directly to Thomas—not to Crown.”
The Supreme Court named the costs of that alternative in the same passage, which the summaries of Connelly v. United States tend to drop. “[E]very arrangement has its own drawbacks”: a cross-purchase agreement “would have required each brother to pay the premiums for the insurance policy on the other brother, creating a risk that one of them would be unable to do so,” and “it would have had its own tax consequences.” The Court did not identify those consequences and did not weigh them. It also set out what the brothers bought by choosing the structure they did: “By opting to have Crown purchase the life-insurance policies and pay the premiums, the Connelly brothers guaranteed that the policies would remain in force and that the insurance proceeds would be available to fund the redemption.”
The point the Connelly opinion actually makes is about authorship of the number. The higher valuation, the Supreme Court said, “is simply a consequence of how the Connelly brothers chose to structure their agreement” — it followed from a private contract drafted years earlier, run through a federal valuation standard neither brother chose and no appraiser could vary. Which structure suits a particular company, and what it costs under tax rules the Court left untouched, is a question for counsel and a tax adviser on the facts of that company. The Business Valuation Institute maps what the law does to a valuation; it does not recommend a structure or advise on tax.
Does the price in a buy-sell agreement fix the estate tax value of the shares?
Not by itself. IRC § 2703(a) directs that “the value of any property shall be determined without regard to” any option, agreement or other right to acquire or use the property at a price less than its fair market value, or any restriction on the right to sell or use it — unless the arrangement meets all three requirements of § 2703(b): it “is a bona fide business arrangement,” it “is not a device to transfer such property to members of the decedent’s family for less than full and adequate consideration in money or money’s worth,” and “[i]ts terms are comparable to similar arrangements entered into by persons in an arms’ length transaction.” The Supreme Court put the practical consequence in a single line in Connelly v. United States: a share redemption agreement “may delineate how to set a price for the shares,” but “it is ordinarily not dispositive for valuing the decedent’s shares for the estate tax.”
Two regulatory paragraphs do most of the litigating. Treasury Regulation § 25.2703-1(b)(3) deems all three requirements met where more than 50 percent by value of the property subject to the right or restriction is owned, directly or indirectly, by individuals who are not members of the transferor’s family, provided their property is subject to the right or restriction to the same extent as the transferor’s. Treasury Regulation § 25.2703-1(b)(4)(i) then measures comparability against industry practice rather than against the agreement in isolation: a right or restriction is comparable if it “could have been obtained in a fair bargain among unrelated parties in the same business dealing with each other at arm’s length,” and it is considered such a fair bargain “if it conforms with the general practice of unrelated parties under negotiated agreements in the same business.”
Clearing IRC § 2703 is necessary rather than sufficient, and the Connelly litigation is the illustration. Treasury Regulation § 20.2031-2(h) provides that the effect given to an option or contract price “depends upon the circumstances of the particular case,” and that “[l]ittle weight will be accorded a price” under an agreement leaving the decedent free to dispose of the underlying securities at any price during his lifetime. Reading that regulation together with § 2703, the Eighth Circuit found that the Connelly stock-purchase agreement “fixed no price nor prescribed a formula for arriving at one”: it offered a Certificate of Agreed Value that was “essentially, an agreement to agree,” and an appraisal mechanism that the parties never used, the $3 million figure having come instead from an “amicable agreement” reached after the death. Crown C Supply’s value therefore had to be determined “without regard” to the agreement. The buy-sell agreements subject area takes the recurring drafting failures in turn.
Is the insurance question one for the appraiser or one for the court?
For the court, and Connelly v. United States is a clean demonstration of it. Whether the life-insurance proceeds sat on the asset side of the computation or were canceled by the redemption obligation was resolved without any trial of value: the District Court granted summary judgment to the Government, the Eighth Circuit reviewed that grant de novo, and the Supreme Court affirmed. The estate’s appraiser never opined on the question — the Supreme Court records that the accounting firm’s analyst “took as given the holding in Estate of Blount v. Commissioner, 428 F. 3d 1338 (CA11 2005)” and excluded the proceeds on that authority. Everything else about Crown C Supply was common ground: both sides put $3.86 million on the company’s other assets and income-generating potential, and the whole deficiency turned on the $3 million the appraiser had left out.
The layer beneath the legal question stays factual, and the Connelly record shows where the line falls. The standard was fixed by regulation long before anyone was engaged: Treasury Regulation § 20.2031-1(b) defines fair market value as “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts,” and fixes the moment as the time of the decedent’s death. Revenue Ruling 59-60 § 3.01 then concedes what is left over: “A determination of fair market value, being a question of fact, will depend upon the circumstances in each case. No formula can be devised that will be generally applicable to the multitude of different valuation issues arising in estate and gift tax cases.” In a refund suit the burden of that factual question sits with the taxpayer — the Eighth Circuit in Connelly restated the rule that “[t]he [IRS’s] determination of a tax deficiency is presumptively correct, and the taxpayer bears the burden of proving that the determination is arbitrary or erroneous.” The fair value and fair market value subject area sets out how the two layers separate across proceedings.
One thing Connelly v. United States does not decide is worth stating, because it is already being read into the case. The opinion says nothing about discounts: the estate’s analyst and the Internal Revenue Service both computed the value of Michael Connelly’s shares as a straight 77.18% of whatever the corporation was worth, and neither figure applied a discount for lack of control or lack of marketability. Whether a shareholder-level discount is available in a transfer-tax matter, and on what evidence, is a separate question governed by different authority; the discounts and premiums subject area treats it, and this Institute publishes no discount figures.