Understanding the Connelly Ruling: What Business Owners Need to Know
The estate plan business owners thought was going to save their family from estate taxes may actually end up costing them millions. Business owners need to pay attention to the Connelly v. United States (2024) Supreme Court ruling. This case has reshaped how life insurance and buy-sell agreements impact estate taxation, potentially changing long-standing succession plans. If you’re running a closely held business, have a buy-sell agreement, or rely on life insurance as part of your succession plan, buckle up—because this case just changed the game. And if you’re thinking, "Great, another tax law headache," I hear you. But stick with me, because knowing what’s coming can mean the difference between a smooth transition and a financial nightmare for your heirs.
What Happened in Connelly?
Let’s set the stage. Two brothers, Michael and his sibling, owned a business together. Michael owned a majority stake, but they each carried the same amount of life insurance on one another. Their buy-sell agreement was funded with entity-owned life insurance, but they did not adhere to its terms. The agreement had not been properly updated, and the valuation process was not followed, creating a tax complication. The company received a $3 million life insurance payout and used it to redeem his shares, which seemed like a textbook plan. But then the IRS came knocking. They claimed the business was actually worth $6.86 million, not the $3 million the estate reported. Why? Because the IRS decided that the life insurance proceeds were a corporate asset, not just a tool for succession planning. The Supreme Court agreed. And just like that, a strategy business owners have used for decades got thrown under the microscope.
Why This Matters to You
Here’s the deal: if your company owns a life insurance policy on you or your partners, those proceeds are now firmly on the table when calculating your estate’s taxable value. That means your heirs could face an estate tax bill based on a business valuation that’s inflated by money they never actually see. Ouch.
And the buy-sell agreement? If it’s structured as an entity purchase (meaning the company itself buys back the shares), the IRS won’t let you simply subtract the insurance payout from the valuation. Your estate could be taxed on a business value that includes the life insurance payout. This could leave your heirs struggling to find liquidity to cover unexpected tax obligations.
The Cross-Purchase Solution
Now, before you start hyperventilating into a paper bag, there’s good news: there’s a way to sidestep this mess. Enter the cross-purchase agreement. Instead of the company owning the insurance, each business partner owns a policy on the others. When one partner dies, the survivor(s) get the insurance payout personally, and they use that cash to buy out the deceased’s shares. Because the business never touches the money, the insurance proceeds don’t inflate the company’s valuation. No IRS red flags. No unexpected tax bomb. Just a clean, efficient transition.
What You Should Do Right Now
Review Your Buy-Sell Agreement – If your plan relies on a stock redemption funded by corporate-owned life insurance, it’s time to rethink the setup.
Talk to Your Tax and Estate Planning Team – You need advisors who understand this ruling and can ensure your strategy won’t leave your heirs footing an outsized tax bill.
Consider Alternative Structures – Whether it’s switching to a cross-purchase plan, using a life insurance LLC, or setting up an irrevocable life insurance trust (ILIT), there are ways to protect your business’s legacy without triggering unintended tax consequences.
Act Sooner Rather Than Later – With the federal estate tax exemption set to drop in 2026, more businesses will be affected by estate taxation. The time to fix this is now.
The Bottom Line
The Connelly ruling is a wake-up call for business owners. What used to be a reliable estate planning strategy now comes with a tax trap that could cost your heirs dearly. But with the right planning, you can still create a seamless, tax-efficient transition. The key is being proactive.
The next step is to evaluate your business succession plan carefully. Work with financial and legal professionals to determine whether Connelly affects your strategy and take action to safeguard your business legacy. Because in the world of estate planning and business continuity, what you don’t know can hurt you. And when it comes to keeping your legacy intact, ignorance is not an option.
