Trusts and Estates
Connelly v. United States
Cite as 23-146
Filed June 6, 2024
U.S. Supreme Court
By Michelle Barnett Batista
Aaron, Riechert, Carpol & Riffle, APC
www.arcr.com
Headnote: Federal Estate Tax – Valuation of Closely Held Corporation
Summary: A corporation’s contractual obligation to redeem shares is not necessarily a liability that reduces a corporation’s value for purposes of the federal estate tax.
Brothers Michael and Thomas were the sole shareholders in Crown C Supply (“Crown”). The brothers agreed that if either Michael or Thomas died, the surviving brother had the option to purchase the deceased brother’s shares. If the survivor declined, Crown was contractually required to redeem the shares at fair market value. To ensure sufficient funds to redeem the shares, Crown obtained $3.5 million in life insurance on each brother. Michael died in 2013 and Thomas declined to purchase his shares, triggering Crown’s redemption obligation. Thomas, as executor, filed a federal estate tax return and reported the value of Michael’s shares as $3 million. Crown then used $3 million in life insurance proceeds to redeem the shares. The Internal Revenue Service (“IRS”) audited the return. During the audit, an outside accounting firm determined that Crown’s total fair market value at Michael’s death was $3.86 million. The valuation excluded the $3 million in insurance proceeds used to redeem Michael’s shares on the theory that their value was offset by the redemption obligation. The IRS disagreed. The IRS determined that Crown’s redemption obligation did not offset the life insurance proceeds and assessed Crown’s total value as $6.86 million, resulting in a tax deficiency. The estate paid the deficiency and Thomas sued the United States for a refund. The District Court granted summary judgment to the Government and the Eight Circuit affirmed.
The Supreme Court grant certiorari and affirmed. An obligation to redeem shares at fair market value does not offset the value of life insurance proceeds set aside for the redemption because a share redemption at fair market value does not affect any shareholder’s economic interest. The Court rejected Thomas’s position that all redemption obligations reduce a corporation’s net value and, in a footnote, acknowledged that there are situations where a redemption obligation could decrease a corporation’s value. For instance, a redemption obligation could require a corporation to liquidate operating assets to pay for the shares, thereby decreasing its future earning capacity.