The United States Supreme Court has agreed on December 13th to hear arguments in the case Connelly v. United States. Their decision will play a significant role in resolving a division within the circuits on the proper estate tax valuation of a deceased’s shares in a privately-held business.
This case emphasizes the significance of two strategic moves that legal practitioners can implement to safeguard their business-owning clients. The paramount two being stock-purchase agreements and life insurance arrangements.
Stock-Purchase Agreements
Legal practitioners should closely consider the terms and actions of stock-purchase agreements. In the Connelly case, a key issue was whether a stock-purchase agreement was within the legal exception, allowing the agreement to establish the estate tax value of a decedent’s stock. Even though there are specific requirements under Section 2703 of the tax code for a stock-purchase agreement to determine the estate tax value, in this case, the Connellys failed to include a “fixed and determinable” price in the agreement, which many courts have pointed out as crucial.
Life Insurance
The primary matter in Connelly is how to account for the proceeds of a life insurance policy when calculating the fair market value of a privately-held business for estate tax purposes. Legal professionals are generally advised to encourage their clients to steer clear of arrangements like the one which landed the Connelly’s in court. Clients may consider taking life insurance policies to ensure the necessary liquidity whilst also minimizing the risk of increasing the value of the decedent’s business. It is also important to be aware that under Section 2042 of the tax code, personal possession of a life insurance policy is not included in the decedent’s taxable estate.
Looking Ahead
This case has led to a court division, with the US Court of Appeals for the Eighth Circuit directly rejecting the reasoning of the Ninth and Eleventh Circuits. The key divergence lies in the treatment of a corresponding redemption obligation where the Ninth and Eleventh Circuits consider it a liability, opposing the Eighth Circuit’s viewpoint. Will a fair market valuation of a business be reliant on the assumption a buyer would buy the entire business and have the power to extinguish an otherwise considerable outstanding liability? The impending ruling in Connelly v. United States may provide some clarity.