What the Supreme Court’s decision means for life insurance-funded buy-sell agreements.
By Andrew R. Silverman
If you own a closely held business, chances are you signed a buy-sell agreement years ago and have not looked at it since. Many of those agreements rely on life insurance to fund the purchase of an owner’s interest following death.
Until recently, business owners and their advisers generally assumed that this arrangement would not increase the estate tax value of the business. The United States Supreme Court’s 2024 decision in Connelly v. United States calls that assumption into question.
For owners whose companies use life insurance to fund a company’s buy-back of a deceased owner’s interest (also known as a redemption), the practical issue is straightforward: Does the buy-sell agreement still operate the way the owners intended? For many businesses, the answer may be no.
How Life Insurance-Funded Buy-Sell Agreements Work
A buy-sell agreement establishes what happens to an owner’s interest when that owner dies, becomes disabled, retires, or experiences another specified event. Upon an owner’s death, the agreement typically requires either the company or the surviving owners to purchase the deceased owner’s interest.
Many buy-sell agreements use life insurance to fund that purchase.
One of the most common arrangements is a redemption agreement. Under this structure, the company owns a life insurance policy on each owner. When an owner dies, the company receives the insurance proceeds and uses them to purchase, or redeem, the deceased owner’s shares from the estate.
The arrangement is popular because it is relatively easy to administer. The company pays the premiums, owns the policies, and handles the buyout. The surviving owners do not have to fund the purchase personally at a difficult time.
The structure historically rested on a seemingly logical assumption. Although the insurance proceeds increase the company’s assets, the company also has an obligation to use those proceeds to redeem the deceased owner’s shares. If the incoming insurance proceeds and outgoing redemption payment offset one another, the insurance should not increase the value of the company or the deceased owner’s interest for estate tax purposes.
In Connelly, the Supreme Court unanimously rejected that assumption under the facts before it.
What Connelly Means for Redemption Buy-Sell Agreements
Connelly v. United States, 602 U.S. 257 (2024), involved two brothers who owned a Missouri building-supply company. Their company had a buy-sell agreement designed to provide for the purchase of an owner’s shares following death.
When one brother, Michael Connelly, died, the company received $3.5 million in life insurance proceeds. It used $3 million to redeem Michael’s shares. His estate valued the company at approximately $3.86 million without including the insurance proceeds.
The IRS took a different position. It included the proceeds and valued the company at $6.86 million. The Supreme Court agreed with the IRS.
The Court reasoned that a redemption at fair market value does not reduce the company’s value in the same way as an ordinary debt. A company with $10 million in assets and an obligation to redeem $3 million of its shares remains worth $10 million immediately before the redemption. After the company pays $3 million and redeems the shares, the remaining shareholders collectively own a company worth $7 million, but they own a larger percentage of it. Their economic position has not been reduced by the redemption obligation.
The life insurance proceeds, by contrast, are an asset of the company and increase its value. The obligation to redeem the deceased owner’s shares generally does not offset that increase.
The result is that company-owned life insurance may increase the value of the very shares the insurance was intended to purchase. The estate may therefore owe tax based on value that it does not ultimately retain.
Consider a company worth $10 million before taking its insurance into account. If the company receives $5 million in death benefits, its value for estate tax purposes may increase to $15 million immediately before the redemption. The deceased owner’s shares are valued using that higher company value, even though the insurance proceeds will be used to purchase those shares.
The Connelly Holding Has Limits
The decision should not be read more broadly than necessary.
The Supreme Court did not hold that a redemption obligation can never affect the value of a company. It left open the possibility that a redemption obligation could reduce value when satisfying it would impair the company’s operations or future earning capacity. For example, the analysis may be different if a company must sell operating assets, incur substantial debt, or otherwise damage its business to complete the redemption.
That was not the situation in Connelly. The company held life insurance specifically intended to fund the purchase. Because the insurance proceeds were available to satisfy the redemption obligation, the payment did not impair the company’s underlying operations.
Most conventional insurance-funded redemption agreements are likely to present the same basic concern. The company owns the policy, receives the proceeds, and uses those proceeds to purchase the deceased owner’s interest. Those arrangements fall within the central reasoning of Connelly.
Why Higher Estate Tax Exemptions Do Not Eliminate the Risk
The federal estate and gift tax exclusion increased to $15 million per person effective January 1, 2026, subject to inflation adjustments. A married couple may be able to shelter $30 million through proper planning, and many estates will not owe federal estate tax.
That does not mean business owners should ignore Connelly.
First, the decision can increase the value being measured. A business worth $9 million, with $6 million of company-owned life insurance, may be treated as a $15 million business upon an owner’s death. The valuation occurs at death, potentially after years of growth and appreciation. Today’s business value may not reflect the value that will be included in an owner’s estate years from now.
Second, the current exclusion has no scheduled expiration, but Congress can change federal tax law. An owner’s estate tax exposure will depend on the law and the value of the business at the time of death, not when the buy-sell agreement was signed or last reviewed.
Third, the choice between a redemption and a cross-purchase arrangement affects more than estate tax. The structure may determine whether surviving owners receive additional tax basis in the acquired interest. It also affects whether the life insurance proceeds are exposed to claims by the company’s creditors.
Pennsylvania business owners should also remember that the Commonwealth’s inheritance tax operates independently of the federal estate tax system. Even when no federal estate tax is due, state-level transfer tax considerations may remain relevant.
The larger federal exclusion reduces the number of estates immediately affected by Connelly, but it does not make the design of the buy-sell agreement irrelevant.
Can the Price in a Buy-Sell Agreement Control Estate Tax Value?
Many owners assume that the price stated in their buy-sell agreement determines the value of the business for estate tax purposes. A well-drafted pricing provision can help prevent disputes among the surviving owners and the deceased owner’s estate. It does not automatically bind the IRS.
Internal Revenue Code § 2703 generally directs the IRS to disregard an agreement that permits property to be acquired for less than fair market value unless the agreement satisfies several requirements. Among other things, the arrangement must serve a bona fide business purpose, cannot operate as a device to transfer property to family members for less than full and adequate consideration, and must contain terms comparable to those found in an arm’s-length transaction.
Courts apply these requirements carefully, particularly when the owners are related.
The agreement in Connelly did not contain a binding fixed or formula price. It contemplated that the brothers would agree on a value each year. They never did. The agreement provided an appraisal process if the parties did not agree, but that process was not followed before the company and the estate negotiated the redemption price.
Better pricing discipline might have reduced uncertainty between the company and the estate. It would not necessarily have changed the treatment of the company-owned life insurance proceeds.
A defensible valuation provision remains an important part of a buy-sell agreement, but it does not, by itself, remove company-owned insurance from the company’s value.
Planning Options After Connelly
There is no single replacement structure that works for every business. The appropriate response depends on the number of owners, the company’s entity and tax classification, the owners’ estate plans, the value and terms of existing policies, and the company’s ability to fund future premiums.
The principal planning options include the following.
Cross-Purchase Agreement
Under a cross-purchase agreement, the individual owners, rather than the company, own life insurance policies on one another. When an owner dies, the surviving owners receive the insurance proceeds and use them to purchase the deceased owner’s interest directly.
Because the insurance proceeds do not enter the company, they do not increase the company’s value. The purchasing owners also generally receive tax basis in the interest they acquire, which may reduce their taxable gain on a later sale.
The disadvantages are practical. Each owner must fund premiums personally. If the company has several owners, the number of required policies can multiply quickly. Changes in ownership may also require corresponding changes to the insurance structure.
Insurance LLC
An insurance LLC may address some of the administrative problems associated with a traditional cross-purchase arrangement. Under this structure, a separate limited liability company, ordinarily taxed as a partnership, owns and administers one life insurance policy for each business owner.
Centralized ownership can reduce the number of policies and simplify premium administration. If properly structured, the arrangement may also qualify for the partnership exception to the transfer-for-value rule under Internal Revenue Code § 101(a)(2)(B).
An insurance LLC is not a plug-and-play solution. Its estate tax treatment relies in part on IRS guidance rather than a definitive judicial framework. The LLC must be respected as a genuine partnership, and the governing documents, economic arrangements, insurance policies, and transfer provisions must work together. This option requires careful design and ongoing administration.
Additional Life Insurance
Owners who want to retain a redemption structure may purchase additional insurance intended to cover both the redemption price and the resulting estate tax exposure.
The approach can work mathematically, but it has limitations. Additional coverage means additional premiums, and the appropriate amount must be reevaluated as the business grows. The proceeds remain company assets and may remain exposed to the company’s creditors. Additional insurance may fund the tax created by the structure without addressing the underlying valuation issue.
Trust Ownership
In appropriate circumstances, an irrevocable life insurance trust may own a policy on a business owner’s life. If properly structured and administered, the proceeds may remain outside both the company and the insured owner’s taxable estate.
Execution is critical. The trust generally must own the policy, not simply be named as its beneficiary. Transferring an existing policy can also create estate tax timing issues and implicate the transfer-for-value rules. A trust-owned policy must be coordinated with the buy-sell agreement, the owner’s estate plan, and the source of premium payments.
Practical Tip: Verify the Insurance Records First
Before changing a buy-sell agreement or moving any policy, confirm:
- Who owns each life insurance policy.
- Who is named as the beneficiary.
- Who pays the premiums.
- Whether any policy has been transferred.
- Whether the coverage remains sufficient in light of the company’s current value.
- Whether the policy terms and designations match the buy-sell agreement.
Insurance paperwork often does not match the owners’ understanding of how the arrangement is supposed to work. A change in ownership, beneficiary designation, or premium arrangement may also have tax consequences. Moving an existing policy can raise issues that would not arise if the parties purchased a new policy.
The policy records and the agreement should therefore be reviewed together.
When Should Business Owners Review Their Buy-Sell Agreements?
A review following Connelly does not need to become an open-ended business succession planning exercise. It should begin with a focused examination of:
- The structure of the existing buy-sell agreement.
- The ownership and beneficiary designations for each life insurance policy.
- The agreement’s valuation and pricing provisions.
- Compliance with Internal Revenue Code § 2703.
- The company’s entity and tax classification.
- The income tax basis consequences to the surviving owners.
- The potential exposure of insurance proceeds to company creditors.
- The relationship between the buy-sell agreement and each owner’s estate plan.
For some businesses, the existing redemption structure may remain appropriate. For others, a cross-purchase agreement, insurance LLC, trust-owned policy, or another modification may better accomplish the owners’ objectives.
Business owners should consider a review if their agreement has not been examined since Connelly, particularly where the business has experienced significant growth, an owner’s health has changed, the company is preparing for a transaction, or the ownership group expects to change.
The most important step is to understand how the agreement and insurance policies work before an owner dies. A buy-sell agreement should provide certainty at a difficult time. It should not create an estate tax result that the owners never intended.
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