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Business owners who once felt confident in the security of their buy/sell agreements may need to reconsider their strategies following a landmark Supreme Court ruling this summer. The decision in the “Connelly case” upheld the IRS’ position on how life insurance proceeds should be treated for federal estate tax purposes, sending ripples through the business community.
The case serves as a stark reminder that even well-established agreements may not be sufficient. For business owners, this underscores the importance of revisiting — or potentially rethinking — their succession plans to avoid unintended financial and/or legal consequences.
The Connelly case originated after an owner of Crown C Supply, a family-owned business, passed away. When the deceased owner’s brother declined to purchase his shares, the company was obligated to redeem them using life insurance proceeds. This action inadvertently increased the valuation of the firm, leading to a higher estate tax liability.
The case highlights a critical flaw in many buy/sell agreements — they often fail to account for the complexities of business growth and changing tax regulations. Buy/sell agreements — which are legally binding contracts outlining how shares are managed in the event of an owner’s death, disability, retirement, or departure — are a cornerstone of business succession planning. However, as the Connelly case demonstrates, these agreements can become outdated or inadequate, leaving businesses vulnerable to significant financial risks.
The ruling is a wake-up call for business owners to reassess their succession plans for potential adjustments. With the Supreme Court’s decision shifting the tax and legislative foundation, the legacy and future of many businesses may be at risk. To safeguard their interests, business owners should consult with wealth managers who offer comprehensive services tailored to their unique situations. By doing so, they can avoid the pitfalls that befell Crown C Supply and ensure their businesses remain protected.
The importance of revisiting buy/sell agreements
The first step for business owners is to determine whether they even have a buy/sell agreement in place. According to the U.S. Chamber of Commerce, there are 33.2 million small businesses in the United States. Yet data from the Exit Planning Institute reveals that nearly a third of these businesses have not considered succession or estate planning. This means approximately 11 million businesses are operating without a clear plan for managing ownership transitions, leaving them exposed to potential challenges.
For owners who have established buy/sell agreements, the Connelly case highlights the importance of revisiting these contracts on a regular basis. Ideally, business owners should review their agreements annually to ensure they remain aligned with the company’s growth and evolving needs.
As businesses expand, their complexity increases, often necessitating additional expertise in areas such as tax planning, estate planning, and even insurance. McKinsey & Company emphasizes that businesses must adapt their strategies to reflect current and future needs, which may involve adding or adjusting services to support their growth trajectories.
The role of wealth managers in succession planning
Given the intricacies of modern business operations, owners should seek guidance from wealth managers who specialize in navigating the intersection of personal and business finances. A skilled advisory team can provide a comprehensive toolbox for succession and estate planning, drawing on experts from various disciplines to address the unique challenges faced by each business. This collaborative approach ensures that all aspects of the business — from tax implications to insurance needs — are carefully considered and integrated into a cohesive plan.
By working with an advisory team, business owners can proactively address potential gaps in their succession plans and mitigate risks associated with unexpected events, such as the death or departure of an owner. This proactive approach can not only protect the business, but also preserve its legacy for future generations.
A call to action
The Connelly case provides a powerful reminder that business succession planning should be an ongoing process. It requires careful consideration of the company’s growth, changing tax laws, and the dynamic needs of its owners. Business owners who neglect this critical aspect of planning risk jeopardizing their firm’s legacy and the financial security of their heirs.
The case is more than just a legal precedent; it is a call to action for business owners to reevaluate their succession plans and take the necessary steps to protect their interests. As such, it often requires several specialized centers of influence to secure that future — particularly in light of the aforementioned Supreme Court ruling.
Paul Saganey CFP®, CEO, and founder at Integrated Partners, is the co-author of “Center Stage: How to Become the Star of Your Practice,” “Optimizing the Financial Lives of Clients: Harness the Power of an Accounting Firm’s Elite Wealth Management Practice” and “Making Smart Decisions: How Ultra-Wealthy Families Get Superior Wealth Planning Results.”
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
