Is It Time to Reconsider Business Owned Life Insurance for Funding Buy-Sell Agreements?
One of the major problems with all buy-sell agreements is finding the funds to enable the buyer to purchase the interest of a deceased owner. Life insurance is a tidy solution when it is available and affordable because:
- The insurance death proceeds are paid at the time when the obligation to purchase the business interest is triggered.
- Properly structured, the proceeds may be received income tax-free under IRC § 101(a).1
- The cost of the life insurance is generally less than the death benefit received.
However, funding a buy-sell arrangement with life insurance has its own issues. One issue is the treatment of the proceeds on the estate valuation of the business when life insurance is used to fund an entity purchase/ stock redemption buy-sell arrangement.
Prior to the June 6, 2024, Supreme Court decision in Connelly v. US2, the main case regarding the impact of business owned life insurance on the value of a business for estate tax purposes was Estate of Blount v. Commissioner3. The Blount case held that the estate value of a company would not be increased by the value of the death benefit of life insurance when its purpose is to provide liquidity to a company to redeem a decedent’s ownership interest. In other words, the value of the life insurance proceeds was offset by the entity’s redemption obligation. However, in Connelly a unanimous Supreme Court rejected this approach; finding that for estate tax purposes life insurance proceeds are an asset that must be included in the calculation of the business value and that an entity purchase/stock redemption buy-sell agreement did not reduce the value.
