A buy-sell agreement is supposed to answer the hardest question in a closely held business before anyone needs to ask it: when an owner dies, retires, divorces, or leaves, who buys the shares and at what price? For decades, many owners funded those agreements with company-owned life insurance and assumed the estate tax value would follow the agreed price.
In June 2024, the U.S. Supreme Court unanimously rejected a key part of that assumption in Connelly v. United States. If your company has a buy-sell agreement funded with life insurance, or if your agreement relies on a stale fixed price, now is the time for a buy-sell agreement valuation review.
Key Takeaways
- In Connelly v. United States (2024), the Supreme Court held that company-owned life insurance proceeds can increase share value for estate tax, without an offset for the redemption obligation.
- A buy-sell price fixes estate tax value only if the agreement meets Section 2703 and the owners actually follow it.
- Review the structure (redemption vs. cross-purchase), the valuation clause, insurance coverage, and estate plan coordination.
- Regular independent valuations make an agreement more credible to the IRS and reduce disputes among owners.
What Happened in Connelly v. United States
Two brothers owned Crown C Supply, a roofing and siding business. Their agreement gave the surviving brother the option to buy a deceased brother’s shares and, if he declined, required the corporation to redeem them. The corporation owned life insurance on each brother to fund the redemption.
When Michael Connelly died, the company received about $3.5 million in insurance proceeds and used $3 million to redeem his shares. The estate reported his shares at $3 million. The IRS argued the company’s value had to include the insurance proceeds, without subtracting the redemption obligation.
The Supreme Court agreed with the IRS. A willing buyer of the company just before the redemption would pay for all of its assets, including the insurance proceeds, and the obligation to buy back shares at fair market value does not reduce the value of the shares being redeemed. The result was a higher estate tax value and additional estate tax.
The practical lesson: In an entity-redemption agreement, life insurance proceeds received by the company can increase the value of a deceased owner’s shares for estate tax purposes. The agreed price in the contract does not automatically control.
Why the Agreement Price Did Not Control
Even before Connelly reached the Supreme Court, the lower courts found that the brothers’ agreement did not fix the estate tax value. Under Section 2703 of the Internal Revenue Code and related case law, a buy-sell price is generally respected for estate tax purposes only if the agreement:
- Is a bona fide business arrangement,
- Is not a device to transfer the property to family members for less than full and adequate consideration, and
- Has terms comparable to similar arrangements entered into by persons in an arm’s-length transaction.
The Connelly brothers had not followed their own pricing mechanism, had not obtained the appraisals their agreement contemplated, and agreed on a price informally after the death. That pattern is common in family companies, and it is exactly what courts look for.
Five Things to Review in Your Buy-Sell Agreement Now
1. The Structure: Redemption vs. Cross-Purchase
In a redemption (entity-purchase) agreement, the company buys the shares and usually owns the insurance. After Connelly, insurance proceeds may increase the value of the decedent’s stake. In a cross-purchase agreement, the owners buy each other’s shares and own policies on each other, so the proceeds do not flow through the company. Cross-purchase arrangements can be harder to administer with many owners, but alternatives such as a trusteed cross-purchase or an insurance LLC can help. Your attorney and insurance advisor should evaluate which structure fits.
2. The Valuation Clause
Many agreements rely on a fixed price that was set years ago and never updated, or on a vague formula. Look for answers to these questions:
- What standard of value applies: fair market value, fair value, or a defined contractual value?
- What level of value applies: a pro rata share of the whole company, or a minority interest with discounts?
- How is life insurance treated in the price: included, excluded, or offset?
- What is the valuation date: date of death, the end of the prior fiscal year, or something else?
- Who selects the appraiser, and what happens if the parties disagree?
Ambiguity on these points is one of the most common sources of litigation between surviving owners and estates. Our guide to fair market value vs. fair value explains why the choice of standard matters so much.
3. Whether You Have Followed It
An agreement that calls for an annual valuation but has not been updated in a decade is weak evidence of value. Courts in Connelly and similar cases gave significant weight to whether the owners actually followed their pricing mechanism.
4. Insurance Coverage vs. Current Value
If the business has grown, the insurance may no longer cover the purchase price. If it has shrunk, the company may be overinsured. Both create problems.
5. Estate Planning Coordination
With the federal estate tax exemption at $15 million per person in 2026 under the One Big Beautiful Bill Act, many owners are not exposed to federal estate tax. But larger estates still are, and Massachusetts imposes its own estate tax on estates above $2 million. A buy-sell agreement should be coordinated with the owners’ estate plans, not drafted in isolation. See our related guide on estate and gift tax valuation in 2026.
How a Buy-Sell Valuation Works
A valuation prepared for a buy-sell agreement follows the same professional standards as any other valuation but is tailored to the agreement’s definitions. The appraiser will:
- Read the agreement carefully and apply its defined standard and level of value
- Analyze historical and projected financial performance
- Apply the income, market, and asset approaches as appropriate
- Treat life insurance, non-operating assets, and excess cash consistently with the agreement
- Apply or exclude discounts for lack of control and marketability as the agreement requires
Many owners now commission a valuation when the agreement is signed and update it at regular intervals. This creates a record that the price reflects arm’s-length value, supports insurance coverage decisions, and reduces conflict later.
A Simple Illustration
Assume a company is worth $6 million before any insurance and has two equal owners. The company owns a $3 million policy on each owner. When one owner dies, the company collects $3 million, so its assets are worth $9 million just before the redemption.
Under the Connelly reasoning, the deceased owner’s 50% interest would be measured against the $9 million value, or $4.5 million, rather than the $3 million the agreement may have specified. If the estate is taxable, that difference can produce a significant additional tax bill. This example is simplified, but it shows why structure and wording matter.
Illustrative Example: Two Founders, One Outdated Number
Picture two hypothetical co-founders of a Worcester County precision machining company. In 2012 they signed a redemption agreement setting a fixed price of $2 million for each 50% interest and bought company-owned policies to match. The agreement called for the price to be updated annually. It never was.
By 2026, the business has grown and an independent appraisal would likely support an enterprise value far above the original figure. If one founder died today, three problems would surface at once. First, the estate would receive a price far below current value, which invites a dispute with the surviving owner. Second, under the Connelly reasoning, the insurance proceeds received by the company could increase the value of the deceased founder’s shares for estate tax purposes, while the estate receives only the stale contract price. Third, the insurance coverage would no longer match the redemption obligation.
The solution is not complicated, but it requires coordination: an independent valuation to establish current value, an attorney’s review of whether a cross-purchase or insurance LLC structure fits better, an insurance review to right-size coverage, and an amendment that defines the standard of value, level of value, treatment of insurance, and a regular revaluation schedule. Owners who complete those steps while everyone is healthy avoid forcing their families to solve the problem later.
Frequently Asked Questions
The insurance holding is the headline, but the case also reinforces that a buy-sell price will not fix estate tax value unless the agreement satisfies Section 2703 and the parties follow it. That applies to every agreement.
Possibly, but not automatically. Ownership transfers of existing policies can raise transfer-for-value and other tax issues. Talk with your attorney, CPA, and insurance advisor before changing anything.
Annually is a common best practice, and at a minimum whenever there is a major change in the business, an ownership change, or a significant change in insurance coverage.
An independent, credentialed valuation professional who has no stake in the outcome. Valuations prepared by an owner or by a party to the agreement carry little weight with the IRS or a court.
Review Your Agreement With Foxboro Consulting Group
Foxboro Consulting Group, Inc. prepares buy-sell agreement valuations, shareholder buyout valuations, and estate tax valuations for closely held businesses throughout New England and the Northeast. We work with your attorney and insurance advisor so the valuation clause, the insurance, and the estate plan all point in the same direction.
Not sure your agreement would survive a Connelly-style review? Contact Foxboro Consulting Group to schedule a buy-sell valuation consultation.
