Does a buy-sell agreement set the value of a business for estate tax?

Does a buy-sell agreement set the value of a business for estate tax?

Usually not on its own. Internal Revenue Code §2703(a) directs that, for purposes of the estate, gift and generation-skipping transfer taxes, the value of any property “shall be determined without regard to” (1) “any option, agreement, or other right to acquire or use the property at a price less than the fair market value of the property (without regard to such option, agreement, or right)” and (2) “any restriction on the right to sell or use such property.” A buy-sell agreement is precisely that kind of right or restriction. It is disregarded for transfer-tax valuation unless it meets every requirement of §2703(b), and even then a second and older body of law has to be satisfied before the contract price controls. The Supreme Court put the general rule in one line while describing a share redemption agreement in Connelly v. United States, No. 23-146 (U.S. 6 June 2024): “Although such an agreement may delineate how to set a price for the shares, it is ordinarily not dispositive for valuing the decedent’s shares for the estate tax. See 26 U. S. C. §2703.”

The reach of §2703 is wider than the phrase “buy-sell agreement” suggests, and the label on the document does not decide whether the section applies. Treas. Reg. §25.2703-1(a)(3) provides that “[a] right or restriction may be contained in a partnership agreement, articles of incorporation, corporate bylaws, a shareholders’ agreement, or any other agreement,” and adds that “[a] right or restriction may be implicit in the capital structure of an entity.” Timing does matter. Treas. Reg. §20.2031-2(h) directs the reader to “section 2703 and the regulations at § 25.2703 of this chapter for special rules involving options and agreements (including contracts to purchase) entered into (or substantially modified after) October 8, 1990,” and Treas. Reg. §25.2703-1(c)(1) treats a substantially modified right or restriction as one created on the date of that modification — so an arrangement signed before that date can be brought inside §2703 by a later amendment.

Whether the agreement controls is a question of law, and it is answered before anyone opens a spreadsheet. The Internal Revenue Code and the Treasury regulations decide whether the price term is looked at or ignored; if it is ignored, the shares are valued under the ordinary fair market value standard of Treas. Reg. §20.2031-1(b) and Rev. Rul. 59-60, and what they are then worth is a question of fact on the record of that matter. That division — the standard of value supplied from outside the appraisal, the number found inside it — is the structure of this whole area. See Buy-sell agreements for how a contractual standard of value is tested, and Estate and gift valuation for the fair market value machinery that applies when the agreement is disregarded.

What does Internal Revenue Code section 2703 require for a buy-sell agreement’s price to control?

Three requirements, and the statute states them in three short clauses. Under Internal Revenue Code §2703(b), subsection (a) “shall not apply to any option, agreement, right, or restriction which meets each of the following requirements: (1) It is a bona fide business arrangement. (2) 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. (3) Its terms are comparable to similar arrangements entered into by persons in an arms’ length transaction.” Treas. Reg. §25.2703-1(b)(2) forecloses the reading that these are factors to be balanced: “Each of the three requirements described in paragraph (b)(1) of this section must be independently satisfied for a right or restriction to meet this exception. Thus, for example, the mere showing that a right or restriction is a bona fide business arrangement is not sufficient to establish that the right or restriction is not a device to transfer property for less than full and adequate consideration.” The regulation also states the device requirement in slightly broader terms than the statute — a right or restriction that “is not a device to transfer property to the natural objects of the transferor’s bounty for less than full and adequate consideration in money or money’s worth” — and fixes the comparability test at a moment, “[a]t the time the right or restriction is created.”

Comparability is measured against industry practice rather than against the agreement’s internal logic, and that is where a formula price becomes exposed. Treas. Reg. §25.2703-1(b)(4)(i) provides that a right or restriction “is treated as comparable to similar arrangements entered into by persons in an arm’s length transaction if the right or restriction is one that could have been obtained in a fair bargain among unrelated parties in the same business dealing with each other at arm’s length,” and that it “is considered a fair bargain among unrelated parties in the same business if it conforms with the general practice of unrelated parties under negotiated agreements in the same business.” The regulation adds that evidence of general business practice “is not met by showing isolated comparables.” The question a book-value or fixed-multiple formula has to answer is therefore not whether it looked reasonable to the shareholders who signed it, but whether unrelated parties in that business generally negotiate that term. This Institute publishes no view on which formulas satisfy that test and no figure a reader could adopt.

One exception removes the question altogether, and it turns on who else owns the property. Treas. Reg. §25.2703-1(b)(3) provides that a right or restriction is considered to meet each of the three requirements if “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,” and it attaches a second condition — “the property owned by those individuals must be subject to the right or restriction to the same extent as the property owned by the transferor.” Both halves have to be true. Whatever the position is at signing can also be reset. Treas. Reg. §25.2703-1(c)(1) provides that “[a] right or restriction that is substantially modified is treated as a right or restriction created on the date of the modification,” that any discretionary modification producing “other than a de minimis change to the quality, value, or timing of the rights of any party” is a substantial modification, “whether or not authorized by the terms of the agreement,” and — the trap for agreements built on a periodically refreshed price — that “[i]f the terms of the right or restriction require periodic updating, the failure to update is presumed to substantially modify the right or restriction unless it can be shown that updating would not have resulted in a substantial modification.”

Is meeting section 2703(b) enough for the agreement’s price to control the estate tax value?

No. Section 2703(b) removes one obstacle; it does not supply an affirmative rule that the contract price becomes the estate tax value. Courts read §2703 together with the older regulation it was enacted against, Treas. Reg. §20.2031-2(h), which requires its own showing. The Eighth Circuit set out the relationship in the Connelly appeal, Connelly v. Department of Treasury, IRS, 70 F.4th 412 (8th Cir. 2023) — the same case the Supreme Court later affirmed under the caption Connelly v. United States — noting that Congress enacted §2703 against the backdrop of §20.2031-2(h), “which has remained substantially unchanged,” and that courts have since interpreted the two in tandem. It quoted Estate of Amlie v. Commissioner, 91 T.C.M. (CCH) 1017, 1024 (2006) — “[R]egardless of whether section 2703 applies to a restrictive agreement, the agreement must satisfy the requirements of pre-section-2703 law to control value for Federal estate tax purposes” — together with Estate of Blount v. Commissioner, 428 F.3d 1338, 1343 n.4 (11th Cir. 2005), that “[c]ourts generally agree that the limitation in . . . § 2703 should be read in conjunction with the court-created rule,” and cited Estate of True v. Commissioner, 390 F.3d 1210, 1231 (10th Cir. 2004), as describing §2703 as “essentially codif[ying] the rules laid out in § 20.2031-2(h)” that had existed before §2703 was added in 1990.

Treasury Regulation §20.2031-2(h) is short and it is unfriendly to loosely drafted agreements. It makes the whole question circumstantial: the effect, “if any,” that is given to an option or contract price in determining the value of securities for estate tax purposes “depends upon the circumstances of the particular case.” It then discounts the one-sided arrangement: “Little weight will be accorded a price contained in an option or contract under which the decedent is free to dispose of the underlying securities at any price he chooses during his lifetime.” And it sets the substantive bar even where the decedent was bound: “Even if the decedent is not free to dispose of the underlying securities at other than the option or contract price, such price will be disregarded in determining the value of the securities unless it is determined under the circumstances of the particular case that the agreement represents a bona fide business arrangement and not a device to pass the decedent’s shares to the natural objects of his bounty for less than an adequate and full consideration in money or money’s worth.”

Two further requirements come from the case law reading that regulation, and the first is where agreements most often fail. The price must be fixed or determinable under the agreement itself: “It is axiomatic that the offering price must be fixed and determinable under the agreement,” Estate of Lauder v. Commissioner, 64 T.C.M. (CCH) 1643, 1656 (1992). Collecting Estate of Blount, Estate of True and Estate of Gloeckner v. Commissioner, 152 F.3d 208, 213 (2d Cir. 1998), the Eighth Circuit summarized the position as “[c]ourts thus recognize that an agreement must contain a fixed or determinable price if it is to be considered for valuation purposes.” It expressly declined to fix the precise contours of that line, offering only that it suffices “to think of a determinable price as one arrived at by ‘formula,’ … as by a ‘fair, objective measure,’ … or ‘calculation.’” The second requirement is that “the terms of the agreement [be] binding throughout life and death,” Estate of True v. Commissioner, 390 F.3d 1210, 1218 (10th Cir. 2004) — the mirror image of the lifetime freedom to dispose that Treas. Reg. §20.2031-2(h) accords little weight.

Why did the buy-sell agreement in Connelly v. United States not fix the estate tax value?

Because the brothers’ stock-purchase agreement fixed no price and prescribed no formula, and because the parties then ignored the pricing machinery it did contain. Michael and Thomas Connelly were the sole shareholders of Crown C Supply, a building supply corporation in St. Louis; under their agreement, if one brother died the surviving brother had the option to purchase the deceased brother’s shares, and if he declined, Crown itself was contractually required to redeem them. On the Eighth Circuit’s reading in Connelly v. Department of Treasury, IRS, 70 F.4th 412 (8th Cir. 2023), “the stock-purchase agreement fixed no price nor prescribed a formula for arriving at one. It merely laid out two mechanisms by which the brothers might agree on a price.” The principal one required them to execute a new certificate of agreed value at the end of every tax year, which the court described as “nothing more than price by ‘mutual agreement’ — essentially, an agreement to agree.” The other was an appraisal process, and although it “seems to carry more objectivity,” the court found “nothing in the stock-purchase agreement, aside from minor limitations on valuation factors, that fixes or prescribes a formula or measure for determining the price that the appraisers will reach.”

What the parties did after the death mattered as much as what the document said. The agreement required the appointed appraisers to “independently determine and submit” their “appraisal[s] of the fair market value of the Company,” after which the brothers were to average the results or consult a third appraiser as a tiebreaker. The Eighth Circuit’s finding on that machinery was one sentence long: “None of this was ever done.” No certificate of agreed value was ever executed either. Instead, the surviving brother and the decedent’s son settled on a figure in what the court called an “amicable agreement” resolving outstanding estate-administration matters. That failed on two counts — the price was chosen after the death, while Internal Revenue Code §2031(a) requires value to be determined at the time of the decedent’s death, and it did not come from the agreement’s mechanisms at all. Citing St. Louis County Bank v. United States, 674 F.2d 1207, 1211 (8th Cir. 1982), the court noted that post-death conduct may be relevant to understanding the nature of the agreement. Its conclusion followed: “under the circumstances of th[is] particular case,” neither price mechanism constituted a fixed or determinable price for valuation purposes, and the company’s “value must be determined ‘without regard’ to the stock-purchase agreement.”

That §2703 analysis is Eighth Circuit law rather than Supreme Court law, and the distinction is worth keeping straight, because Connelly is usually described as a single holding. The Supreme Court granted certiorari on the separate question of whether life-insurance proceeds that will be used to redeem a decedent’s shares must be included when calculating the value of those shares, and it decided only that, affirming. Connelly v. United States, No. 23-146 (U.S. 6 June 2024). The buy-sell half of the case — that an agreement supplying no fixed or determinable price is disregarded under §2703(a) — was resolved below and left undisturbed. Nothing here is an opinion on the value of any interest in any company, and nothing here states what rule governs any particular agreement.

Does a company’s obligation to redeem a deceased shareholder’s shares reduce the company’s value for estate tax?

Not necessarily. That is the holding of Connelly v. United States, No. 23-146 (U.S. 6 June 2024), where a unanimous Court concluded in its own words that “Crown’s contractual obligation to redeem Michael’s shares did not diminish the value of those shares” and that “redemption obligations are not necessarily liabilities that reduce a corporation’s value for purposes of the federal estate tax.” The reasoning is an arithmetic point about redemptions rather than a rule about insurance. Writing for the Court, Justice Thomas explained that “[a]n 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,” and that “a corporation’s contractual obligation to redeem shares at fair market value does not reduce the value of those shares in and of itself.” It followed 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.” On the Court’s own recitation of the figures, the corporation was worth $6.86 million at the death — $3 million of life-insurance proceeds earmarked for the redemption plus $3.86 million in other assets and income-generating potential — so that the decedent’s 77.18% stake was valued at $5.3 million rather than the $3 million the estate had reported, and the Internal Revenue Service determined that the estate owed an additional $889,914 in taxes.

The regulation had already said the proceeds count. Treasury Regulation §20.2031-2(f)(2), quoted by the Court in Connelly v. United States, directs that closely held stock be valued by considering “the company’s net worth, prospective earning power and dividend-paying capacity, and other relevant factors,” “including proceeds of life insurance policies payable to . . . the company.” What had kept the question live was a contrary line of reasoning in the Eleventh Circuit: Estate of Blount v. Commissioner, 428 F.3d 1338, 1345 (11th Cir. 2005), concluded that insurance proceeds should be “deduct[ed] . . . from the value” of a corporation where they are “offset by an obligation to pay those proceeds to the estate in a stock buyout,” and the Ninth Circuit had reasoned similarly in Estate of Cartwright v. Commissioner, 183 F.3d 1034, 1038 (9th Cir. 1999). The estate’s analyst in Connelly took the Blount holding as given when preparing, during the Internal Revenue Service audit, the valuation the estate relied on. The Eighth Circuit rejected that reasoning in terms — “Blount’s flaw lies in its premise. An obligation to redeem shares is not a liability in the ordinary business sense” — and the Supreme Court affirmed, citing the Tax Court proceedings in Blount as an instance of the post-redemption view it declined to adopt.

The holding has an express limit, stated in a footnote that summaries routinely drop. “We do not hold that a redemption obligation can never decrease a corporation’s value,” the Court wrote. “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 Court also observed that the 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” — while noting in the same passage that “every arrangement has its own drawbacks,” including that such a structure “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 that “it would have had its own tax consequences.” It concluded that the outcome “is simply a consequence of how the Connelly brothers chose to structure their agreement.” That is a report of what the Court said, not a recommendation: the Institute does not advise on how any arrangement should be structured.

If a buy-sell agreement does not control the estate tax value, is it still enforceable between the shareholders?

Yes — those are two different questions, decided by two different bodies of law, and Internal Revenue Code §2703 answers only one of them. Section 2703(a) opens with the words “For purposes of this subtitle,” meaning subtitle B of the Internal Revenue Code: the estate, gift and generation-skipping transfer taxes. Treasury Regulation §25.2703-1(a)(1) says the same thing in its own words — “For purposes of subtitle B (relating to estate, gift, and generation-skipping transfer taxes), the value of any property is determined without regard to any right or restriction relating to the property.” Nothing in that provision makes a contract void, voidable or unenforceable. Whether the surviving owners must buy and the estate must sell, and at what price, is a question of state contract law and of the agreement’s own terms. So an agreement can be entirely binding, and entirely performed, and still leave the estate taxed on a materially different number. That gap is the exposure §2703 creates, and it is invisible from inside the contract.

The recurring disputes cluster on a small set of features of the document rather than on valuation technique. The price term comes first — whether the agreement supplies a price that is fixed or determinable, or only a process for arriving at one later, which is the ground the Eighth Circuit decided the Connelly appeal on. Naming “fair market value” and stopping there is a second, because the phrase does not by itself specify the level of value or say whether adjustments for control and marketability are contemplated. A formula that was defensible at signing and is not at the trigger is a third, and Treas. Reg. §25.2703-1(b)(1)(iii) sharpens it by testing comparability “[a]t the time the right or restriction is created” rather than when it operates. Silence on how appraisers are selected is a fourth, and it generates litigation about process before any number exists. This Institute maps what the contract did to the valuation; drafting the contract and enforcing it are counsel’s.

A transfer restriction is also not the same thing as a price, and the Tax Court has said what a bare restriction is worth. In Mandelbaum v. Commissioner, T.C. Memo. 1995-255, the court found the taxpayer’s expert’s heavy reliance on shareholders’ agreements “especially troublesome, given the fact that the agreements specify no price or formula (such as book value per share) at which the shares must be offered,” and reasoned that “[i]n most cases, especially where an operating company is concerned, a right of first refusal without a fixed price has little, if any, effect on fair market value,” because such a right “does not limit the buyers to whom a seller could sell his or her stock, or the price for that stock, but merely governs the order in which prospective buyers must stand in line to buy the stock.” A clause that reorders the queue neither fixes the transfer-tax value under Treas. Reg. §20.2031-2(h) nor, on that reasoning, does much to reduce fair market value under Rev. Rul. 59-60. Every statute, regulation and quoted opinion in this article was checked against the United States Code, the Code of Federal Regulations or the issuing court’s own text in September 2026. Nothing here states what rule governs any particular agreement, estate or interest, or what any interest is worth — see Buy-sell agreements for the contractual standard of value, Family entities and transfer restrictions for how the Code treats restrictions inside family-controlled entities, and Shareholder oppression and business divorce for what happens when the same agreement is litigated between the owners rather than against the Internal Revenue Service.