By George Paulsen, CPA - Tax and Advisory Partner
As a tax advisor and life insurance agent, I have been contacting my corporate clients that own life insurance on their owners as part of their business plan. For years, planners often had companies buy life insurance to provide funds to assist in the buyout of an owner’s interest and provide money to the business to hire a replacement or cover cash flow needs during a transition.
A few months ago, with the Connelly v. United States, No. 23-146 (U.S. June 6, 2024) U.S. Supreme Court ruling, estate planning for business owners got turned on its head. The decision reinforced the existing law and corrected conventional planning that was based on appellate decisions that I believe were wrongly decided. The decision will have strong implications for S Corporations and regular corporate entities, and partnerships should look at how their buy-sell is structured so that this effect can be minimized.
What happened with the SCOTUS decision is that the life insurance proceeds mature upon the death of the insured, so this adds to the net assets and increases value. This extra value creates additional estate tax if the estate is not exempt.
As an example, if the deceased owner was covered with $5 million in insurance, that amount is added to the appraised value of the business and the estate will be taxed on an additional $2.5 million at 40%, ultimately costing the estate $1 million in additional taxes.
In the case, the Connelly attorney argued that a decision in favor of the government would make succession planning harder – which the court acknowledged while noting that the structure of the agreement could have been organized differently to avoid the result.
In many cases the business plan must change to get that value out of the estate. The insurance needs to be owned and held by another owner or entity. If the estate value of the decedent is below the taxable amount, then this may not be an issue. However, the exemption from estate tax sunsets at the end of 2025. If the incoming Trump administration does not change the law, estates with assets of over $6 million will be affected. If you have a business succession plan with corporate-owned life insurance, you should talk to your Hood & Strong tax advisor and your insurance agent to restructure your plan.
