Buy Sell Agreements After Connelly: Is Your Life Insurance Funding Still Working?

By Michael P. Barry, LMB Partners

Most closely held companies with more than one owner have, or should have, an agreement that says what happens to an owner's interest when that owner dies. Many of those agreements are funded with life insurance. In 2024 the United States Supreme Court decided Connelly v. United States, and the decision changed the math for one of the most common ways those agreements are set up. If your company owns life insurance on its owners to fund a buyout, the agreement deserves a fresh look.

What happened in Connelly

Brothers Michael and Thomas Connelly owned Crown C Supply, a building materials company in St. Louis. Their agreement required the company to buy back a deceased brother's shares, and the company bought $3.5 million of life insurance on each brother to fund the purchase. When Michael died, the company used the insurance proceeds to redeem his shares for $3 million, a price his son and Thomas agreed on without obtaining the appraisal the agreement called for.

The IRS valued the company at about $6.86 million, counting the insurance proceeds as a company asset, and assessed more than $890,000 in additional estate tax. The estate argued that the company's obligation to use those proceeds to buy back Michael's shares offset their value. In a unanimous opinion issued June 6, 2024, the Supreme Court sided with the IRS. The Court held that a company's obligation to redeem shares at fair market value is not a liability that reduces the company's value, so the insurance proceeds increased the value of the company and of the deceased owner's shares.

Why it matters

When a company owns the policy, the death benefit becomes a company asset at the moment it is needed. Under Connelly, that asset raises the value of the shares being purchased, which has two consequences. The deceased owner's estate may face a larger estate tax bill than the owners expected. And if the agreement sets the purchase price by formula or by appraisal, the insurance may no longer cover the full price, because the price itself rises with the proceeds.

The federal estate and gift tax exemption became $15 million per person in 2026 and is now indexed for inflation without a scheduled sunset, so many owners will not owe federal estate tax at all. The decision still matters for owners whose estates approach that level, and it matters for every owner on the question of price. An agreement that no longer produces a fair, funded price can leave the surviving owners and the deceased owner's family in a dispute at the worst possible time.

Alternatives to consider

The Court noted that the result might have been different under a cross purchase agreement, in which each owner buys insurance on the other owners and uses the proceeds to buy the deceased owner's interest directly. Because the company does not own the policies, the proceeds do not increase the company's value. Cross purchase arrangements have tradeoffs of their own. They become unwieldy as the number of owners grows, the policies are personal assets that can lapse if an owner stops paying premiums, and owners of different ages pay very different premiums.

Other structures include holding the policies in a separate entity owned by the business owners, a combination agreement that gives the owners the first option to buy and the company a backup obligation, and adjusting the amount of coverage so that a company owned policy funds the higher price that Connelly produces. The right answer depends on the number of owners, their ages and health, the company's tax classification, and how the agreement sets the price.

What owners should do now

Find your buyout agreement and read the price provision. Confirm whether the company or the owners own the policies, whether the coverage still matches the value the agreement would produce today, and whether the valuation method the agreement requires is actually being followed. The Connelly estate relied on an agreed price instead of the appraisal its agreement required, and that gap made the estate's position harder to defend. If the agreement is more than a few years old, or the business has grown significantly since it was signed, it is likely time to update it.

If you would like us to review your buy sell agreement or the insurance that funds it, contact LMB Partners at 720.439.2530.

This article is provided for general informational purposes only and does not constitute legal or tax advice. Reading it does not create an attorney client relationship.