Your buy-sell agreement may be designed to protect your business.

But if it relies on company-owned life insurance, it could create an unexpected estate-tax problem.

That is the warning from the U.S. Supreme Court’s 2024 decision in Connelly v. United States.

The ruling changed how many business owners, attorneys, CPAs, and insurance professionals must think about life insurance for business transitions.

The good news?

You still have options.

With the right structure, you can protect your company, provide liquidity to your family, and create a smoother ownership transition: without allowing insurance proceeds to artificially inflate the value of your business interest.

This article is educational only. Buy-sell agreements, business valuations, insurance ownership, and estate-tax planning require coordinated advice from qualified legal, tax, valuation, and insurance professionals.

The Problem: Your “Protection” Could Increase Your Estate

Many closely held businesses use a redemption agreement, also called an entity-purchase agreement.

Here is how it usually works:

1. The business owns life insurance policies on its owners.
2. The business pays the premiums.
3. The business receives the death benefit when an owner dies.
4. The business uses the proceeds to redeem: or buy back: the deceased owner’s shares from the estate.

On paper, this can seem simple.

The business gets the cash.

The family receives money.

The surviving owners keep control.

But what happens when the IRS values the deceased owner’s shares before the redemption occurs?

That is where the Connelly decision matters.

What the Supreme Court Changed in Connelly v. United States

In Connelly, two brothers owned a closely held business.

The company purchased life insurance on both brothers to fund a possible redemption of shares.

When one brother died, the surviving brother declined to purchase the shares personally. The company then redeemed the deceased brother’s shares using the life insurance proceeds.

The estate reported the shares at approximately $3 million.

The IRS disagreed.

The Supreme Court ultimately held that the company’s life insurance proceeds increased the corporation’s fair market value. The company’s contractual obligation to redeem the deceased owner’s shares did not automatically offset the insurance proceeds.

In simple terms:

• The insurance proceeds were treated as a corporate asset.
• That asset increased the value of the company.
• The redemption obligation did not necessarily reduce the company’s value for estate-tax purposes.
• The deceased owner’s estate could therefore be taxed on a higher value than expected.

The Court’s example involved millions of dollars and produced a significant additional estate-tax bill.

The ruling did not say every redemption agreement creates estate tax.

It did say that a company-owned policy used to fund a redemption can create an inflated valuation at the owner’s death.

That is the Connelly trap.

Think of It This Way

Imagine your company is worth $4 million before the insurance proceeds arrive.

The business receives a $3 million death benefit.

For estate-tax valuation purposes, the company may now be viewed as worth approximately $7 million: before the redemption payment is made.

The business may intend to use that $3 million to buy back the deceased owner’s shares.

But under Connelly, that planned payment does not automatically erase the increase in value that occurred when the company received the insurance proceeds.

The estate may face tax on value that feels like it was only passing through the company.

That can create a painful mismatch:

• The family expects a buyout.
• The company expects to use the insurance proceeds for that buyout.
• The estate-tax calculation may still treat the insurance as increasing the value of the deceased owner’s shares.

Why Entity-Owned Insurance Deserves a Fresh Review

Company-owned life insurance is not automatically wrong.

It may still be appropriate in certain situations.

But after Connelly, it should not be treated as a default solution for every business.

You need to ask:

• Who owns the policy?
• Who is the beneficiary?
• Who receives the death benefit?
• Is the agreement a redemption, cross-purchase, or hybrid?
• Is the business value being calculated before or after the redemption?
• Does the agreement satisfy the requirements of IRC §2703?
• Could the insurance proceeds increase the deceased owner’s taxable estate?
• Has the company followed employer-owned life insurance requirements?

The structure matters as much as the amount of insurance.

A large policy placed inside the wrong ownership structure may protect liquidity while creating a new tax exposure.

The Cross-Purchase Solution

A cross-purchase agreement works differently.

Instead of the company owning policies on the owners, the owners generally own policies on one another.

When one owner dies:

1. The surviving owner receives the life insurance proceeds.
2. The surviving owner uses those proceeds to purchase the deceased owner’s shares from the estate.
3. The company does not receive the death benefit.
4. The death benefit does not increase the company’s value in the same way.

The Supreme Court specifically identified a cross-purchase structure as an alternative that could have avoided the insurance-driven valuation issue in Connelly.

Redemption vs. Cross-Purchase

Feature	Redemption Agreement	Cross-Purchase Agreement
Policy owner	Company	Individual owners
Policy beneficiary	Company	Surviving owner or owners
Who receives proceeds?	Business	Surviving owner or owners
Main estate-tax concern	Proceeds may increase company value	Proceeds generally stay outside company value
Administrative challenge	Often simpler with multiple owners	Can become complex as owners increase
Potential basis benefit	May be limited	Surviving buyer may receive basis in purchased shares

A cross-purchase can be especially attractive for businesses with two or a few owners.

But it is not perfect.

Each owner must be able to maintain the policies. Premium responsibilities must be clear. The agreement must be updated when ownership changes. And the structure should be coordinated with the company’s operating documents.

What About an Insurance LLC?

For businesses with multiple owners, a cross-purchase arrangement can require many policies.

That can become expensive and difficult to administer.

For example, with four owners, a traditional cross-purchase structure may require policies covering each owner by the other owners.

A special-purpose insurance LLC may offer another planning approach.

In this structure:

• The owners form a separate LLC.
• The LLC owns and is beneficiary of the policies.
• The operating company does not directly own the policies.
• The LLC’s agreement coordinates with the buy-sell agreement.
• Insurance proceeds may be used to support the ownership transfer.

This can help keep life insurance off the operating company’s balance sheet.

However, an insurance LLC is not a magic fix.

Its tax classification, operating agreement, policy transfers, premium payments, and distribution mechanics must be carefully reviewed.

Moving an existing policy from a corporation to another entity can also raise transfer-for-value concerns.

That is why an insurance LLC should be designed with your attorney, CPA, valuation professional, and insurance advisor: not added as an afterthought.

Do Not Miss IRC §101(j)

Connelly focuses primarily on estate-tax valuation.

IRC §101(j) addresses the income-tax treatment of employer-owned life insurance.

If a business owns a policy on an employee, owner, or other covered individual, the company may need to satisfy specific requirements for the death benefit to receive favorable income-tax treatment.

Before the policy is issued, the insured generally must receive written notice that:

• The business intends to insure the person’s life.
• The maximum face amount of coverage is stated.
• The business may be a beneficiary of the proceeds.

The insured must also provide written consent:

• Agreeing to be insured.
• Agreeing that coverage may continue after employment ends.

The business may also have annual reporting obligations, including Form 8925.

A common mistake is assuming that an owner’s knowledge is enough.

It is not.

IRS Notice 2009-48 makes clear that written notice and written consent matter: even when the insured is an owner of the business.

Do not wait until a claim occurs to discover that the paperwork was incomplete.

Review the requirements with your tax advisor before issuing coverage or materially increasing an existing policy.

How Properly Structured IUL Fits Into the Bigger Picture

Indexed Universal Life insurance, or IUL, can play a role in tax-free wealth transfer strategies and retirement planning for small business owners.

But the purpose must be clear.

An IUL used for personal retirement and legacy planning is different from an employer-owned policy used to fund a buy-sell agreement.

A properly designed IUL may provide:

• Permanent life insurance protection.
• Cash value accumulation potential.
• Access to cash value through policy loans.
• Tax diversification in retirement.
• Death-benefit liquidity for heirs or a business transition.

Policy loans are not automatically “free money.”

The policy must be properly designed and managed. Interest, loan balances, policy performance, insurance costs, and the risk of lapse must all be monitored.

If a policy lapses with an outstanding loan, the resulting taxable income can be substantial.

That is why IUL should be considered as part of a broader strategy: not as a stand-alone promise.

For more context, read our related resources: IUL vs. 401(k) for Business Owners and 5 Steps to a 0% Tax Bracket Retirement.

Common Questions Business Owners Ask

Does Connelly make my buy-sell agreement invalid?

No.

The decision does not automatically invalidate your agreement.

It changes how company-owned life insurance and redemption obligations may be treated when valuing the deceased owner’s shares for estate-tax purposes.

Your agreement should be reviewed: not abandoned.

Is a cross-purchase always better?

Not always.

Cross-purchase agreements may reduce the Connelly valuation concern, but they can create administrative challenges, especially with several owners.

The best structure depends on your entity, ownership, policy design, funding capacity, and long-term transition goals.

Does IRC §2703 solve the problem?

Not necessarily.

Section 2703 affects whether certain buy-sell restrictions or pricing provisions will be respected for estate-tax valuation.

It does not automatically remove company-owned insurance proceeds from the company’s value.

Can I simply transfer the company-owned policy to the owners?

Do not do that without professional advice.

The transfer may create transfer-for-value, income-tax, gift-tax, valuation, or governance issues.

A new ownership structure must be designed: not improvised.

Is IUL the answer to every business transition?

No.

IUL may be appropriate for certain protection, retirement, and legacy goals.

But the policy must fit your financial capacity, insurance need, risk tolerance, and long-term plan.

The right strategy is the one that protects both your business and your family.

Your Next Steps

If you own a business, pull out your current buy-sell agreement.

Then identify:

1. Whether it is a redemption, cross-purchase, or hybrid agreement.
2. Who owns every life insurance policy.
3. Who is the beneficiary.
4. The current death benefit and policy values.
5. Whether §101(j) notice and consent documents are complete.
6. Whether the agreement has been reviewed under the Connelly decision.
7. Whether your business valuation is current.
8. Whether your estate plan aligns with your business transition plan.

Do not wait for a death, disability, sale, or market shock to expose a weakness.

The professional approach is proactive.

It coordinates business continuity, estate protection, retirement income, tax diversification, and legacy planning before a major transition occurs.

If you are unsure whether your current structure creates unnecessary risk, schedule a conversation with Catherine. You do not need to arrive with all the answers.

You only need to start the review.

Protect what you built.

Prepare the next transition.

Create peace of mind for the people and purpose behind your business.

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Catherine Agada
Financial Professional (SMD) | NPN #20555446
Life Transition Specialist | Tax-Free Retirement and Legacy Planning

Contact Catherine | Book a Conversation