You already know a funded buy-sell agreement is how a closely held business stays in the right hands when an owner dies. You can feel the relief that comes with that document sitting in the file. Now notice what most owners never check: the same life insurance that makes the promise keepable can also raise the estate-tax value of the company if the company owns the policy.
On June 6, 2024, the U.S. Supreme Court decided Connelly v. United States unanimously. The Court did not ban insurance-funded buy-sells. It did tell you, in plain language, that you need to review buy-sell agreements after Connelly — and update the key-man and business life insurance that sits beside them.
That is not a technical footnote. That is the difference between a clean transition and a cash bill the family never planned for.
What the Connelly Decision Actually Said
Michael and Thomas Connelly were the only shareholders of a building-supply company. They wanted the business to stay in the family. They signed a buy-sell that gave the surviving brother the first option to buy. If he declined, the company had to redeem the shares at fair market value.
To fund that promise, the company bought and owned a life insurance policy on each brother — $3.5 million each. That is exactly how most redemption agreements are funded, and funding the promise with life insurance remains a sound way to do it.
Michael died. Thomas declined to buy the shares personally. The company used $3 million of the insurance proceeds to redeem Michael’s shares from his estate.
The estate argued the shares were worth about $3 million because the company was already committed to hand the insurance money over. The IRS argued the proceeds were a company asset on the day Michael died and had to be counted in the company’s value, regardless of what the company was obligated to do with the money afterward. On that basis, Michael’s shares were worth about $5.3 million.
The Supreme Court agreed with the IRS. Life insurance owned by a closely held corporation must be included in the value of that corporation for federal estate-tax purposes, even when the company is obligated to use the proceeds to redeem the deceased owner’s shares. The Court rejected the argument that a redemption obligation is a liability that reduces what the company is worth.
The extra federal estate tax on that one estate was roughly $900,000. Not a technical difference. A cash bill the family had not planned for.
What the Court did not say
The Court did not say a redemption obligation can never reduce a company’s value. In a footnote, it gave an example where it might — such as an obligation that forces a company to sell off operating assets and damages its future earnings. The Court rejected only the broader claim that every redemption obligation reduces value, and it deliberately decided nothing more than that.
It is also worth noticing the facts behind the number. The brothers had never set a price for the business and never had it appraised. The figure they used was simply a number they had agreed on. The Court did not decide the case on that point, but it is a reminder that an agreement built on an unsupported number is fragile in more ways than one.
Buy-sell agreements funded with life insurance remain the right way to make sure a business passes cleanly when an owner dies. Connelly did not change that. What it changed is that the structure now has to be checked, because the same funding that makes the promise keepable can also add to the estate-tax bill if the company is the owner of the policy.
Why You Need to Review Buy-Sell Agreements After Connelly
Most agreements I see were drafted to solve a human problem: keep the business with the people who built it, pay the family fairly, and avoid a fire sale. The attorney did the legal work. An agent placed a policy. Then everyone moved on.
Years later, four things have usually drifted:
- The structure no longer matches the tax result you think you have. A “wait-and-see” agreement that gives the surviving owners an option, then requires the company to redeem if they decline, is the Connelly fact pattern. Many hybrid agreements work exactly that way.
- The policy owner and beneficiary are still the company. Company-owned life insurance (COLI) used for a redemption now sits on the valuation. Key-man coverage owned by the company can do the same thing, even when it was never meant to fund a buyout.
- The number in the agreement is stale. Owners change. Real estate inside the entity appreciates. Debt is paid down. A partner retires on paper but still owns stock. The buyout price in the document is often a handshake from a different decade.
- The insurance no longer fits the lives it is supposed to protect. Term that expires at 65. Face amounts that lag the current value. An owner who is now uninsurable. A key employee who became an owner and was never added. Premiums the company stopped paying during a tight year.
As you read that list, you can already see which item belongs to your shop. That recognition is useful. Acting on it is what protects the family.
Estate Tax Implications
The federal estate-tax exemption for 2026 is $15 million per person ($30 million for a married couple), and it is indexed going forward. That higher exemption does not make this a non-issue. Company-owned proceeds can still push a concentrated owner over the line. Several states levy their own estate or inheritance tax at much lower thresholds. And the non-tax problems — a broken valuation, an expired term policy, a key-man policy that pays the company while the family is still waiting for a check — show up whether or not a Form 706 is ever filed.
Redemption, Cross-Purchase, or Something More Innovative
The Court itself pointed to a cleaner path. The brothers could have used a cross-purchase, with the shareholders — not the corporation — owning the policies. In a true cross-purchase, the insurance proceeds never become a corporate asset, the surviving owners receive a cost-basis step-up in the shares they buy, and the Connelly valuation problem does not arise the same way.
Cross-purchase is not free of friction. Two owners need two policies. Three owners need six. Four owners need twelve. Premiums can fall unevenly when ages and health differ. Transfer-for-value rules can surprise you if you move existing company-owned policies the wrong way.
That is why many owners now look past the binary choice.
An insurance LLC for buy-sell agreements lets a separate partnership own the policies, specially allocate the death benefit to the surviving members, and keep the proceeds out of the deceased owner’s estate. The operating company can bonus the premium. Members pick up basis. At a later retirement — not just at death — a properly designed permanent policy inside that LLC can be distributed and used as a Life Insurance Retirement Plan for tax-free income. That is the part conventional buy-sell conversations almost never reach.
Funding the Policies
If the face amount the agreement now requires is large, premium financing can put the death benefit in force without draining operating cash or forcing a sale of producing assets.
None of those tools is a magic wand. Each one has to be coordinated with your attorney and tax advisor. The point is this: you have more than two boxes to check, and the box you checked in 2014 may be the expensive one in 2026.
Key Man and Business Life Insurance Need the Same Review
Owners often treat “the life insurance at the company” as one pile. It is not.
Buy-sell funding is supposed to put cash in the hands of the people who must buy equity.
Key-man (key-person) coverage is supposed to put cash in the company to replace a rainmaker, cover a line of credit, or keep payroll going through the shock.
After Connelly, a company-owned key-man policy still increases company value when the insured dies. That may be acceptable if the estate is well under the exemption and the company truly needs the liquidity. It is a problem if that same policy is the only money anyone is counting on to buy the stock — because the family and the company are now reaching for the same dollars, and the valuation just got larger.
While you are in the file, look at the rest of the business coverage with the same eyes:
- Who is the owner? Who is the beneficiary? Do those designations still match the agreement?
- Is there an assignment to a bank that no longer has the loan?
- Did a partner become disabled, or will the plan fail if one does? Business loan protection disability insurance is the piece most succession plans leave out.
- Are the owners in their sixties, sitting on gains, and still treating a term policy as “good enough”? This is the season to consider permanent design — and, for many, a hybrid life or annuity with long-term care benefits so the same premium conversation protects the business and the household.
A succession plan that only works if everyone dies on schedule, stays healthy, and never changes their mind is not a plan. It is a hope.
A Short Checklist You Can Use This Week
Print this. Walk it with your attorney, your CPA, and an advisor who designs business life insurance for a living — not someone who only quotes term.
- Pull the signed buy-sell. Is it a redemption, a cross-purchase, or a wait-and-see that defaults to the company?
- List every policy the company or the owners hold on an owner or key person. Owner. Beneficiary. Face amount. Type. Whether premiums are still being paid.
- Get a current valuation, or at least a reasoned update to the formula in the agreement. An unsupported number is how families end up arguing with the Service and with each other.
- Compare the death benefit to the current buyout price, including taxes, closing costs, and working-capital needs. Underfunded agreements fail quietly.
- Confirm the transfer-for-value analysis before anyone changes ownership of an existing policy.
- Decide whether the survivors should receive a basis step-up (cross-purchase / insurance LLC) or whether a redemption still serves a non-tax purpose that outweighs the Connelly risk.
- Align disability and long-term care so the plan does not collapse on a living event.
- If a partner is approaching retirement, ask whether the permanent policy can later serve as personal tax-free income instead of being surrendered or forgotten.
As you complete that list, you will notice something simple: the agreement and the insurance either still fit, or they do not. There is no third state. Stale is a decision.
The Innovative Move Most Conventional Agents Never Make
Conventional advice stops at “switch to a cross-purchase.” That can be the right answer. It is not the only answer, and it is rarely the most flexible one.
The owners I work with want the death benefit to do two jobs over a lifetime:
- Job one: fund the buyout, protect the bank, and keep the company out of a forced sale.
- Job two: if everyone lives — which is the outcome you actually want — turn that same overfunded permanent policy into a reservoir of tax-free retirement income that can beat the old 4% rule in the right design.
That second job is why structure matters as much as face amount. A minimally funded term policy inside the company cannot become a retirement asset. A maximum over-funded policy owned in the right place can protect the business and later serve the household. You have already built the company. You might as well let the funding vehicle work as hard as you did.
If your succession plan still includes a seller-financed note, read Uncovering the Hidden Risks in a Business Succession Plan next. A note without life and disability coverage on the right people is a second way the same story ends badly.
What to Do Next
You do not need to panic. You do need to look.
Review buy-sell agreements after Connelly while the owners are healthy, the underwriting is still available, and the conversation is about design instead of damage control.
- Bring the agreement.
- Bring the policy pages.
- Bring last year’s valuation if you have one.
I will show you, in plain language, whether the company-owned insurance is doing the job you think it is doing — and what an insurance LLC, a redesigned cross-purchase, or a properly funded permanent policy would change for your numbers.
The IRS you want on your side is the one that helps you see the structure before the valuation does.
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No Rendering of Advice: The financial content in this document is provided for your personal education. It is not intended for trading purposes, and cannot substitute for professional financial advice. Always seek the advice of a competent financial advisor with any questions you may have regarding a financial matter. Information in this document is not appropriate for the purposes of making a decision to carry out a transaction or trade nor does it provide any form of advice (investment, tax, or legal) amounting to investment advice, or make any recommendations regarding particular financial instruments, investments, or products.
The sole purpose of life insurance is for the death benefit protection. Any other benefit is ancillary.
