As seen from Penn Mutual: Supreme Court decision alters buy-sell planning

by Jenna Washatka, Director at Penn Mutual

On June 6, 2024, the Supreme Court affirmed the Eighth Circuit’s opinion in Connelly v. United States in a unanimous 9-0 decision. This decision shocks the buy-sell system and will significantly impact buy-sell planning going forward.

The case is centered around two brothers who owned Crown C Supply, a small building supply corporation. The brothers had a buy-sell agreement. To fund the agreement, Crown owned a life insurance policy on each brother.

In traditional buy-sell thinking, life insurance proceeds owned by and paid to a business at death of an owner increase the business’s value for estate tax purposes. However, that value is offset by any corresponding buy-sell liability. Said differently: to the extent of the purchase price, there is no net increase in the business valuation for estate tax purposes.

The IRS, the Eighth Circuit, and now the Supreme Court, all disagreed. The Supreme Court held up the fact that life insurance increases the business value and is not offset by any buy-sell liability. For the brothers, this meant more estate tax, to the tune of an additional $889,914 in taxes.

Unfortunately, in this case, the buy-sell agreement itself was problematic—in particular, the agreement did not set a fixed or determinable value for the business, and the brothers had not completed Certificates of Agreed Value each year as required by the agreement.

What does this mean?

Business owners with existing stock redemption or hybrid buy-sell agreements—that is, buy-sell agreements funded with company-owned life insurance—potentially have greater estate tax exposure after this decision. When calculating the taxable estate, the IRS can now include not only shares of the business itself, but life insurance proceeds paid into the business. This means more estate tax.

Business owners should be urged to take several key steps in analyzing how this decision impacts their plan:

  1. Check the estate tax.  This decision primarily impacts business owners with taxable estates. For businesses owned by persons well below the estate tax threshold, a stock redemption may still be appropriate, although several unresolved issues remain (see below). For those at or above the threshold, an estate tax projection can help understand the size of the problem.
  2. Talk to a legal advisor.  Now is an excellent time for business owners to visit their legal advisor to determine if they should update their buy-sell agreement in light of this decision, especially with the sunset of several provisions in the Tax Cuts and Jobs Act (TCJA) scheduled to go into effect on January 1st 2026. 
  3. Consider changing the buy-sell design . If the business owner has both: 1) a stock redemption, and 2) a taxable estate, then a different buy-sell design selected from those listed below may be appropriate. However, beware the transfer-for-value (TFV) rule: moving existing policies without an applicable exception can make death benefits income taxable. Further, moving policies out of a corporation might create other income tax issues to consider.
  4. Increase life insurance coverage.  Another potential solution might be to buy more life insurance to cover the anticipated estate tax (subject to underwriting).

Buy-sell planning going forward

Experts will analyze this case for months—and years—to come. The court did leave some room for stock redemptions in the future, but that future remains unclear. There are many unresolved questions.

For now, here are several alternative designs to consider based on our initial thoughts on how to approach buy-sell planning going forward. When properly structured, each of these buy-sell designs can avoid the estate tax problem presented in Connelly:

  • Cross-purchase. Because insurance is cross-owned by the business owners—outside of the company—death proceeds should not increase the business value. In fact, the Supreme Court itself in Connelly suggested that a cross-purchase would have been a possible solution to avoid the additional estate tax.
  • Partnership Administration Succession Strategy (PASS). By using a cross-purchase design with an insurance LLC—like PASS—the death benefit proceeds should not increase the value of the underlying business itself.
  • Insured-controlled cross-purchase (ICCP). Some carriers, like Penn Mutual, offer this unique buy-sell design. Policies are individually owned by the insured, and the business owners simply endorse a portion of the death benefit to each other. This is a sophisticated, complex design, and when properly structured, may avoid the estate inclusion problem presented in Connelly. However, business owners should work closely with their tax and legal advisors when considering whether the ICCP design is sufficient to remove the endorsed portion of the policy from the estate.
  • Stock redemptions for businesses with no estate tax issue. For businesses owned by persons with estates well below the estate tax threshold, stock redemptions may continue to play an important role. However, this case leaves many unresolved questions, such as: whether it impacts/increases valuation for capital gains purposes, whether stock redemptions funded with assets other than life insurance will impact the valuation for surviving shareholders, and whether this case applies only to corporations or will also apply to other entity types like LLCs, partnerships, etc.

Given this important case law development, business owners with existing buy-sell agreements and/or those looking to enter a buy-sell agreement are urged to review their situation and plan accordingly.


1While the scope of the TFV rule is beyond this alert, two ways to avoid a TFV problem include issuing new policies (as opposed to an ownership transfer) or making sure the insureds are also partners in a partnership.

See original article here. Special thanks to Evan Matthew of Trek Financial.