Two brothers ran a building supply company in Missouri. They did what every advisor tells closely held owners to do: they signed a buy-sell agreement and funded it with life insurance, so that when one died, the company would have cash to buy back his shares and the survivor would keep control. Textbook planning. It cost the family an extra $889,000 in estate tax anyway.
That case — Connelly v. United States — was decided unanimously by the Supreme Court, and it quietly invalidated the assumption underneath a very large share of the buy-sell agreements sitting in owners’ filing cabinets right now. Most of those agreements still have not been revisited. If your company owns life insurance on your partners, this is the conversation to have before the next renewal, not after the next funeral.
The Holding in One Sentence
A corporation’s obligation to redeem a deceased shareholder’s stock is not a liability that reduces the corporation’s value for federal estate tax purposes — so life insurance proceeds the company collects get added to the value of the business, and the estate is taxed on the deceased owner’s share of that inflated number.
What Actually Happened in Connelly
Crown C Supply’s agreement said that on the death of either brother, the company would redeem his shares, and the company bought life insurance to fund it. When the older brother died, the company collected roughly $3 million in insurance and used it to buy his 77 percent stake for $3 million. The estate reported the shares at that value.
The IRS disagreed. Its position: at the date of death the company was worth about $3.86 million as an operating business plus $3 million of insurance proceeds — roughly $6.86 million. Seventy-seven percent of that is about $5.3 million, not $3 million. The estate argued the redemption obligation offset the proceeds, since the cash was earmarked to go straight back out the door. The Supreme Court rejected that reasoning: an obligation to pay fair value for shares does not make a company less valuable, because a buyer of the whole company would still see the insurance as an asset.
The result is a mismatch most owners find genuinely surprising. The estate is taxed on $5.3 million of value and the family receives $3 million of cash. The difference walked out the door to the surviving owner — and the estate paid the tax on it.
Why This Reaches Further Than Estate Tax
The reflexive response in 2026 is that the federal exclusion is a permanent $15 million per person, so almost nobody owes estate tax. That is true for many owners and irrelevant for three groups:
- Owners in estate tax states. Oregon starts at $1 million, Massachusetts at $2 million, and Washington, New York, Illinois, and Minnesota sit well below the federal line. A company comfortably under $15 million federally can still trip a state threshold — and Florida owners frequently hold entities or property in states that impose one.
- Fast-growing companies. A firm worth $8 million today, growing at 12 percent, crosses $15 million in about eight years. Succession documents written for today’s number get used at tomorrow’s.
- Everyone with a redemption structure, regardless of tax. The same logic that inflates estate value hands the surviving owner a windfall: insurance funded the buyout, and the survivor ends up owning 100 percent of a company still carrying the operating value the estate was taxed on. If your agreement was meant to treat partners evenhandedly, it may no longer do that.
In other words, this is a fairness problem wearing a tax costume. Knowing what the buy-sell will actually deliver to each side is the same exercise as any other business valuation — with higher stakes and no chance to renegotiate.
The Three Structures, Compared
| Structure | How It Works | Post-Connelly Assessment |
|---|---|---|
| Entity redemption | Company owns the policies and buys back the deceased owner’s shares | Simplest to administer, but proceeds inflate company value at death. Exposed. |
| Cross-purchase | Each owner personally owns a policy on the other owners and buys the shares directly | Proceeds never touch the company, so no valuation inflation. Surviving owners also get a stepped-up basis in purchased shares. |
| Insurance LLC / partnership | A separate entity owned by the shareholders holds all policies and distributes proceeds to fund a cross-purchase | Cross-purchase economics with one policy per owner instead of N x (N-1). Best fit for three or more owners. |
| Wait-and-see hybrid | Company gets a first option, then the owners, then a mandatory backstop | Flexible, but only helps if the funding sits outside the company. |
The arithmetic problem with a pure cross-purchase is policy count: four owners need twelve policies. That is why the insurance LLC has become the default for anything beyond two owners — four owners, four policies, one entity.
A buy-sell agreement is not a document you sign once. It is a financial model that has to be re-run every time your value, your ownership, or the law changes. All three have changed.
Restructuring Without Creating New Problems
Watch the Transfer-for-Value Rule
Moving existing policies out of the company and into a cross-purchase or insurance LLC can trigger the transfer-for-value rule, which turns otherwise tax-free death benefits into ordinary income. Safe harbors exist — a transfer to a partnership in which the insured is a partner is the one most restructurings rely on — but they are technical and unforgiving. Never move a policy before the structure is documented.
Get the Valuation Clause Right
Under Section 2703, a buy-sell price is respected for estate tax purposes only if the agreement is a bona fide business arrangement, is not a device to pass value to family for less than full consideration, and has terms comparable to what unrelated parties would negotiate. A fixed dollar amount set in 2015 fails all three in practice. Use a formula tied to your actual financials, or require a periodic independent appraisal — then actually perform it.
Make Sure the Numbers Behind the Formula Are Real
A formula built on EBITDA or book value is only as good as the books producing it. If your close is inconsistent or your balance sheet has never been reconciled, the formula generates a number nobody will accept when it matters. Disciplined bookkeeping and consistent financial reporting are the unglamorous foundation of every enforceable buy-sell agreement.
Your 2026 Buy-Sell Review Checklist
- Pull the agreement and confirm whether it is a redemption, cross-purchase, or hybrid.
- List every policy: owner, insured, beneficiary, face amount, and premium payer.
- Compare face amounts to a current valuation — underfunding is as common as the Connelly problem itself.
- Read the valuation clause out loud. If it names a dollar figure or a stale multiple, it needs replacing.
- Confirm the agreement matches your operating agreement, your estate plan, and your actual cap table. Departed partners still listed as parties are routine.
- Model the after-tax outcome for the estate and the survivor under the current structure before changing anything.
The Bottom Line
Connelly did not make company-owned life insurance a bad idea. It made the combination of company-owned insurance and a mandatory redemption obligation an expensive one, for agreements drafted long before anyone could have anticipated the ruling. The fix is usually restructuring who owns the policies, paired with a valuation clause that reflects how the business is actually measured — not a wholesale rewrite.
If your buy-sell agreement has not been reviewed since 2024, assume it needs attention. Schedule a free consultation and our CFO advisory and tax strategy teams will map your structure, quantify the exposure, and coordinate with your attorney and insurance advisor on the fix — while there is still time to make it.
