Supreme Court Decision in Connelly v. United States Alters Estate Tax Treatment of Corporate-Owned Life Insurance Proceeds

On June 6, 2024, the United States Supreme Court issued its decision in in Connelly, As Executor of the Estate of Connelly v. United States, (602 US ________). The decision involves the application of the federal estate tax to insurance proceeds received by a closely held corporation in which the decedent held shares. Many of these corporate-owned life insurance plans have been developed on the basis that insurance proceeds received by a corporation upon a shareholder’s death will have no effect on the value of the deceased shareholder's gift or estate tax liability.  Connelly turns that understanding on its head, and the estates and families of shareholders may be left in the difficult position of paying estate taxes on assets that their loved ones will never receive.

Connelly will require that estate planning firms, financial advisors, insurance brokers, and consultants review their existing portfolio of insurance-funded buy-sell and stock redemption agreements. Under certain circumstances, the Connelly decision could also affect the expected benefits of split-dollar insurance plans, key man insurance arrangements, and other insurance-funded planning vehicles. The Connelly Court suggested the entire problem could have been avoided by eliminating the corporation as a party to stock buy-sell agreements. Such changes in structures are often more easily said than done, particularly as the number of shareholders in a closely held corporation increases.  Further, efforts to address the problem by moving existing policy ownership outside of a corporation may give rise to income taxation concerns under transfer-for-value rules.  Nonetheless, it will be important to review and, if needed, adjust current planning and develop additional strategies for the use of corporate-owned life insurance to fund wealth transfers at death.

The Supreme Court's ruling in Connelly marks a significant shift in the application of federal estate tax to insurance proceeds received by closely held corporations. This decision disrupts long-standing assumptions about the federal estate tax implications of corporate-owned life insurance policies used to fund shareholder buyouts, potentially leaving estates and families liable for taxes on assets they do not actually receive.

More updates and analyses will follow as the implications of this decision unfold.