Thursday, February 6, 2025
By Jeff Velastegui and Evan Rogdakis, Esq.*
The Connelly Ruling and Its Implications
On June 13, 2024, the Supreme Court delivered a landmark decision in Connelly vs. United States, fundamentally altering how entity purchase agreements are taxed. The ruling states that life insurance proceeds paid under these agreements must now be included in the taxable estate of a deceased shareholder. Previously, these proceeds were excluded, but now they contribute to the overall valuation of the business for estate tax purposes.
For business owners relying on entity purchase agreements, this shift creates a significant risk of increased tax liability for heirs. Without proper planning, families could face unexpected estate taxes, reducing the liquidity and stability needed during the transition period after a shareholder’s passing.
Illustrating the Financial and Tax Impact
To understand the ruling’s implications, consider the case of John, a business owner with a thriving company valued at $10 million. John had secured an entity purchase buy-sell agreement funded by a $5 million life insurance policy to ensure a smooth ownership transition in the event of his death.
Under the new Connelly ruling, the $5 million insurance proceeds must now be included in the estate valuation, bringing the total to $15 million. With the current federal estate tax exemption capped at $13.99 million, John’s estate is subject to estate taxes on the additional $1.01 million plus any other assets he may own including homes, retirement assets and life insurance. At a top federal estate tax rate of 40%, John’s estate now faces an additional $404,000 in federal estate taxes and growing. This figure excludes potential state-level taxes, adding further financial pressure to an already challenging situation for his heirs.
This example illustrates how even a well-intentioned plan can create significant tax burdens without proactive adjustments.
Strategies to Adapt to the Connelly Ruling
Business owners must reassess their buy-sell agreements to address these changes and mitigate tax implications. Depending on the specific circumstances, several approaches can provide relief:
1. Cross-Purchase Agreements
In a cross-purchase agreement, surviving owners buy the deceased owner’s shares directly, bypassing the need for life insurance proceeds to be included in the taxable estate. While this strategy can simplify taxation, it can become complex for businesses with multiple owners. Each owner must maintain individual life insurance policies for every other owner, leading to significant administrative and financial challenges.
2. Insurance Entity*
A designated Insurance Limited Liability Company is established to purchase life insurance policies on the owners’ lives. Each owner owns the Insurance, LLC and the insured endorses a portion of the death benefit to the other owners, which serves as a source of funds to purchase the shares of a deceased owner. This structure is particularly effective for businesses with multiple stakeholders to centralize life insurance policies, reduce administrative burdens and ensure that proceeds are distributed efficiently.
*While this strategy can be useful in business planning, it does not negate the Connelly Ruling
3. Trust-Owned Life Insurance (TOLI)
Trust-owned life insurance can be used as an alternative to entity-owned life insurance in buy-sell agreements. The owners would execute a cross-purchase buy-sell agreement and create a revocable or irrevocable trust. The trust is the owner and beneficiary of a life insurance policy on the life of each owner. On the death of an owner, the trustee is obligated to collect the insurance proceeds and distribute them to the surviving owners as beneficiaries of the revocable trust. The surviving owners then have the funds with which to purchase the stock or units of the deceased owner, required by a separate cross-purchase buy-sell agreement. This approach combines tax efficiency with operational simplicity.
4. Tailored Solutions for Unique Needs
Every business has its own complexities, and a one-size-fits-all approach is rarely effective. The above list is not exhaustive or not mutually exclusive. Other solutions may include Endorsement Split Dollar Arrangement, Cross-Purchase Split Dollar Arrangement, Late-Start Endorsement Split Dollar Arrangement, or even a Keep the Entity Purchase Arrangement and Buy Additional Personal Coverage option. Collaborating with experienced legal, financial, and tax advisors can uncover tailored strategies to address the Connelly ruling’s impact on your business.
Why Address This Now?
The Connelly ruling serves as a timely reminder of the importance of proactive planning. For many business owners, buy-sell agreements are more than just financial arrangements—they represent a promise to protect the legacy they’ve worked hard to build.
Delaying action could leave your family and business partners vulnerable to unexpected financial challenges. By reviewing and updating your agreements now, you ensure they align with the latest legal requirements while supporting the long-term goals of your business and loved ones. Proactive planning ensures financial security and supports a seamless transition for your business.
FAQs About the Connelly vs. United States Ruling
- What is the key takeaway from the Connelly vs. United States ruling?
The Supreme Court ruled that life insurance proceeds tied to entity purchase agreements must be included in the taxable estate of the deceased shareholder. This increases the estate tax liability for heirs.
- Who is most affected by this ruling?
Business owners with entity purchase buy-sell agreements are the primary group affected, particularly those using life insurance to fund share purchases.
- What are the main strategies to mitigate the tax implications?
Options include transitioning to a cross-purchase agreement, utilizing trust-owned life insurance (TOLI), or creating an insurance LLC to manage policies efficiently.
- How does The Legacy Group approach these challenges?
Using our 3-Dimensional Planning Approach™, we collaborate with legal, financial, and tax experts to create tailored solutions that protect your business and legacy.
Moving Forward
Addressing the complexities of the Connelly ruling doesn’t have to be overwhelming. Trusted advisors can help you navigate the available options and create a plan that protects both your financial interests and the emotional well-being of those involved.
Whether you’re considering a cross-purchase agreement, exploring trust-owned life insurance, or revising your existing strategy, a thoughtful approach is key. Taking the time to plan today ensures your agreements remain effective and aligned with your long-term goals.
📩 Contact us today to schedule a consultation. Let’s create a robust, tax-efficient plan that provides peace of mind for you and your loved ones. Visit The Legacy Group’s Estate Planning Page to learn more or contact us at info@legacygroupny.com or call (516) 682-3383.
*Not practicing on behalf of MML Investors Services, LLC or its affiliated companies
Any discussion of taxes is for general information purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate.
Securities, investment advisory and financial planning services offered through qualified registered representatives of MML Investor Services, LLC. Member SIPC. The Legacy Group is not a subsidiary of MML Investors Services, LLC or its affiliated companies. 1693 Veterans Memorial Hwy, Suite 307S, Hauppauge, NY 11788. 516-682-3383. CRN202801-7958139
About Jeff
Jeff Velastegui is Founder and Personal Estate & Business Advisor at The Legacy Group, a financial planning firm dedicated to helping high-net-worth individuals, business owners, and executives build, preserve, and transfer wealth in the Long Island and Metro New York area. With over 20 years of experience in fee-based financial planning, Jeff is known for his “service-first” approach, offering personalized estate planning, business succession strategies, and wealth management. His proprietary 3-Dimensional Planning process brings together financial, legal, and accounting perspectives to help create cohesive and future-ready client plans.
Jeff’s mission is to “reach people in time to make a difference,” a passion sparked by helping his mother avoid an unsuitable financial product when he was young. This experience inspired him to guide others toward informed decisions and financial confidence. After beginning his career at Thrivent Financial and later Sagemark Consulting, Jeff joined the Center for Wealth Preservation in 2007, where he honed his collaborative planning philosophy. He founded The Legacy Group to help clients live a life of greater confidence, choice, and financial freedom through strategic planning and unparalleled advice.
Jeff obtained a business management and finance degree from the City University of NY and is licensed to sell insurance and securities in multiple states, enabling him to offer a comprehensive range of financial strategies. Living in Centerport, New York, with his wife, Pam, and their two children, Nicolas and Isabella, Jeff is an active member of his community, serving on nonprofit boards and mentoring young adults through his Sonrisa Foundation. Outside of work, he enjoys skiing, snowboarding, and spending time outdoors with his family. To learn more about Jeff, connect with him on LinkedIn.
