The IRS and Business Valuations: Why Your Buy-Sell Agreement May Be at Risk
You’ve spent years building your business, carefully planning for its future. You even have a buy-sell agreement in place, thinking you’ve covered all your bases. Then the IRS shows up, flips through your agreement, and decides your valuation is all wrong. Suddenly, your heirs are staring at a tax bill they never expected. Sound far-fetched? It’s not. And thanks to Connelly v. United States (2024), it’s happening more than ever. And guess what? That means more taxes, more headaches, and more scrambling for liquidity at exactly the worst possible time.
The IRS Has Its Own Opinion on What Your Business is Worth
You might think your buy-sell agreement sets the value of your business. The IRS isn’t just out to make life difficult. Their goal is to ensure that taxable estates reflect a business’s true fair market value—whether or not your buy-sell agreement aligns with that assessment. If your agreement undervalues the business, they’ll override it, often using external market data or their own valuation experts to justify a higher number. And if your agreement doesn’t meet their criteria? They’ll throw it out faster than last year’s tax deduction.
Here’s the kicker: If your buy-sell agreement undervalues the business, the IRS can and will step in to apply a “fair market value” that’s significantly higher. That means your estate (or your partner’s estate, if they’re the one who passes first) could owe estate taxes on a valuation that’s way beyond what you planned for.
Connelly v. United States: The Case That Changed Everything
If business owners weren’t already sweating over IRS scrutiny, Connelly v. United States (2024) turned up the heat. This Supreme Court ruling made it clear that buy-sell agreements funded with corporate-owned life insurance aren’t immune to valuation inflation. The IRS successfully argued that life insurance proceeds should be included in the company’s valuation, even if those funds were earmarked for a stock redemption.
The result? A higher taxable estate and a bigger estate tax bill. And if your agreement hasn’t been structured properly, your heirs could be the ones left scrambling to cover the shortfall.
What Puts Your Buy-Sell Agreement at Risk?
So what exactly makes a buy-sell agreement vulnerable to IRS scrutiny? Here’s where most business owners trip up:
Fixed-Price Agreements That Ignore Fair Market Value – Instead of locking in a price, use a valuation formula or require periodic appraisals to ensure compliance.
Ignoring Life Insurance Proceeds in Valuation – Adjust your buy-sell agreement now to account for the Connelly ruling and prevent unexpected tax liabilities.
Lack of Periodic Updates – Commit to updating your valuation every 2-3 years to reflect market changes and maintain compliance.
Failure to Follow the Agreement’s Terms – If the agreement says shares will be redeemed at a specific value but the actual transaction doesn’t follow those terms, the IRS sees that as a red flag.
How to Bulletproof Your Buy-Sell Agreement
The good news? You can avoid these tax landmines with the right planning. Here’s how:
Get Regular Valuations – Work with a qualified appraiser to update your business valuation every few years. This helps ensure that your agreement reflects the true market value and stands up to IRS scrutiny.
Consider a Cross-Purchase Agreement Instead – Instead of having the company own life insurance, a cross-purchase agreement keeps policies in the hands of the business partners, avoiding valuation inflation.
Rework Entity-Purchase Agreements with IRS Compliance in Mind – If your business does own the policies, make sure your agreement accounts for the Connelly ruling and properly structures the redemption.
Work with Tax and Legal Professionals – Estate and tax attorneys who specialize in business succession planning can help ensure your agreement is rock solid.
Final Thoughts: Fix It Now Before the IRS Fixes It for You
Your buy-sell agreement is supposed to protect your business and your heirs. But if it’s outdated or doesn’t meet IRS standards, it could do the exact opposite—triggering unnecessary estate taxes and creating a financial crisis at the worst possible time.
You built your business with a plan in mind. Now, make sure the IRS doesn’t rewrite it for you. Get your buy-sell agreement reviewed, update your valuations, and ensure your estate plan doesn’t leave your heirs with a tax nightmare. The best time to fix this was before Connelly. The second-best time? Right now. Because when the IRS decides your business is worth more than you planned for, the last thing you want is to find out the hard way.
