Estate Tax Implication of Funding Buy-Sell Agreement with Life Insurance

In a unanimous ruling, the Supreme Court, in Connelly v. United States, 602 U.S., 2024 WL 3859749 (June 6, 2024), affirmed a decision of the Eighth Circuit that the value of a corporation must include the proceeds of life insurance received at a deceased shareholder's death, with no offset for the obligation to apply those proceeds to purchase the decedent's shares pursuant to a buy-sell agreement.

Hence, when a business owner is insured by a policy that is owned by the business, the proceeds of the policy will increase the value of the Company, thereby increasing the business owner’s gross taxable estate for estate tax purposes. Additionally, most people purchase life insurance in their own names. However, life insurance purchased in your name is subject to inclusion in your estate for purposes of determining your taxable estate. Consequently, the more insurance you buy to pay estate taxes or to fund a buyout under a buy-sell agreement, the more estate taxes you incur. It is a vicious cycle. One way out of this cycle is to transfer a life insurance policy (subject to the 3-year rule) to an Irrevocable Life Insurance Trust (“ILIT”) or purchase a life insurance policy in the name of an ILIT.

I recommend that you review your life insurance policies along with your buy-sell agreements and existing estate plan for estate tax planning opportunities. For a detailed explanation of how the result of this case affects your current estate plan or to set up a meeting to review your current estate plan, please call Esther A. Streete at 410-266-9909.