How the Connelly Decision Is Reshaping Business Valuations
In our recent overview of the 59th Annual Heckerling Institute on Estate Planning, we covered key sessions that explored emerging valuation issues and legal developments shaping estate and gift tax planning. One session that drew particular attention was on the Connelly v. United States—a Supreme Court decision that marks a significant shift in how buy-sell agreements are treated for valuation and estate tax purposes.
A Turning Point for Valuation and Estate Planning
For decades, buy-sell agreements have been a cornerstone of business continuity planning, providing a clear roadmap for ownership transition in the event of a partner’s death, retirement, or other triggering events. These agreements have helped mitigate disruption, preserve business value, and protect the financial interests of all stakeholders.
However, as noted above, the recent Connelly decision has introduced a major shift in how these agreements impact a company’s overall value. The ruling redefines how company-owned life insurance is treated for valuation and estate tax purposes, introducing a layer of complexity that could catch business owners and estate planners off guard.
The decision may lead to inflated valuations and higher estate tax liabilities. As a result, business owners, estate planners, and valuation professionals must reevaluate how buy-sell agreements are structured and how value is calculated under this new legal precedent.
What Changed: A Closer Look at the Connelly Ruling
Traditionally, businesses have used company-owned life insurance to fund buyouts when an owner or key stakeholder passes away. In many cases, these proceeds were excluded from the company’s valuation, arguing that the funds were for a specific purpose in the form of a repurchase obligation or offsetting liability, therefore not contributing to the company’s net equity value. The Court rejected that rationale, insisting the proceeds do in fact increase a company’s fair market value. So, life insurance proceeds are now more likely to be counted as part of the company’s overall value unless buy-sell agreements and insurance policies are carefully crafted.
This decision fundamentally alters the estate planning and valuation landscape for businesses that rely on life insurance to fund buyouts. What was once a reliable estate planning strategy now carries unintended tax risk. Now, outcomes may vary from an estate being redeemed at a detriment with a windfall by the remaining shareholders, or conversely, the company itself may be disadvantaged by having to fund a portion of the buyout.
What This Means for Business Owners and Valuation Professionals
The Connelly decision sends a clear message: buy-sell agreements need reassessment, and valuation professionals must adapt their approach to account for life insurance proceeds when determining a company’s worth, considering the specific buy-sell and insurance structure, policy holders, designated beneficiaries, and repurchase obligations. Moving forward, business owners and advisors should consider the following actions to stay compliant and avoid costly surprises:
•Reevaluate existing buy-sell agreements by working collaboratively with legal, tax, insurance, and valuation professionals to ensure these agreements adequately reflect the parties’ intentions and desired outcomes. Prior agreements may now create unintended estate tax liabilities.
•Adjust tax planning strategies to account for the potential increased value until or unless agreements are restructured. Without careful recalibration, estates may face issues when settling unexpected tax bills.
•Engage valuation professionals early in the planning process. Accurate, defensible valuations are now more critical than ever, particularly when life insurance proceeds may influence equity value.
•Business owners and business entities should be sure to follow their buy-sell agreement provisions carefully when a triggering event occurs. In the case of Connelly, it appears the business and its owners compounded their problems by not following their own agreement’s procedures to have a certificate of value or an independent valuation.
When a limited number of owners exist, it’s worth exploring alternative buy-sell structures, such as cross-purchase, to reduce the risk of life insurance proceeds factoring into the company’s valuation. These agreements typically involve each owner holding a life insurance policy, enabling the surviving parties to fund the buyout in the event of one passing away. Other flexible succession planning strategies include irrevocable life insurance trusts or non-insurance-based mechanisms to provide better alignment with both tax and valuation objectives.
A New Era for Buy-Sell Agreements
The Supreme Court’s decision in Connelly introduces a level of complexity that reshapes how we think about ownership transitions and estate planning. What was once a relatively straightforward exercise now requires deeper coordination among legal, tax, insurance, and valuation experts.
This ruling underscores the importance of preemptive, collaborative planning. Business owners can no longer afford to treat valuations as a formality. Instead, it must be a proactive, strategic element of buy-sell agreements, ensuring alignment with both regulatory standards and long-term goals.
Redwood Can Help
In light of this ruling, closely held businesses and their advisors must act now. Whether you’re reviewing an existing agreement or structuring a new one, Redwood Valuation can help ensure your valuation approach is both defensible and foresighted. Our team helps clients navigate evolving tax regulations while maintaining the integrity of their succession plans, ensuring agreements remain effective, compliant, and technically sound.