Will a Business Owned Buy-Sell Life Insurance Policy Increase the Value of a Descendant’s Business Interest?

Situation: One of the chief concerns for owners of a closely held business is what will happen to the business if one of the owners can no longer continue. Surviving owners generally want to ensure a continuity of ownership and management without having the departing owner’s successor thrust upon them. Disabled or deceased owners want their families compensated fairly for their business value and, where applicable, they want this value to be respected for estate tax purposes.

I suspect that, as experienced practitioners, we have all stated that a properly drafted buy-sell agreement will address all the above goals by:

• Providing that upon the occurrence of specific “trigger events,” owners are assured that their interest in the business will be purchased;
• Providing that an owner’s interest must be sold to the company, the remaining owners, or a combination of the two; and
• Establishing a valuation formula that will help ensure the family is compensated fairly and be respected for estate tax purposes.

Equally important to having a properly drafted buyout agreement is making sure the continuity of the business is not compromised by requiring buyout payments/terms that significantly burden the business. Neither the surviving owner(s) nor the departing owner wants to unduly compromise the continuity of the business by requiring payments that create a burden. Consequently, many buy-sell agreements are funded, in whole or in part, by life insurance on the lives of individual owners.

Life insurance is a tidy solution for funding a buy-sell agreement when it is available and affordable. However, because of the recent Supreme Court decision in Connelly v. US,1 it is important to think through the implications of life insurance from a valuation perspective when the business is the owner and beneficiary of the policy. In this Counselor’s Corner we will discuss how life insurance proceeds received by the business can impact the valuation of a deceased owner’s business interest.

Solution: Before we discuss the impact life insurance proceeds can have on the valuation of a business, it’s helpful to review the rules regarding how a buy-sell agreement can “fix” the estate tax value of a business.

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