What is your Business Worth? Buy-Sells and the Connelly Case

Is your business worth more to the IRS than it is to you? Will you owe estate tax on more value than you receive? A recent tax case illustrates how this is possible.[1] It is very common, even advisable, that closely-held business owners enter into buy-sell agreements limiting transferability of interests and setting forth procedures for buying interests from an owner at death setting reasonable expectations and giving owners some level of comfortable reliance on the future of their business arrangements.


In the Connelly case, such a buy-sell agreement was in place. The estate of Michael P. Connelly, Sr., the deceased owner, was redeemed out of the business based on a valuation of the business at approximately $3.86 million. The IRS argued that life insurance death benefits paid to the business to fund the redemption added to the business valuation, increasing the estate tax value to $6.86 million. The U.S. District Court for the Eastern District of Missouri granted summary judgment to the IRS resulting in the estate receiving $3 million in redemption but being taxed on a significantly higher valuation.[2]

The business, Crown C Supply, Inc., was owned by two brothers, one being the decedent.[3] The decedent owned 77.18% and his brother owned the balance. Many years before the death of either, the brothers entered into a buy-sell agreement intended to keep the business in their family.[4] The agreement required the brothers to attach a “Certificate of Agreed Value” annually which would set buy-sell values.[5] If they failed to do so, then the stock would be determined based on appraisal.[6] After receiving $3.5 million in death benefits following the majority shareholder’s death, the estate (the executor of which was the other shareholder/brother, Thomas A. Connelly) agreed to a redemption price of $3 million which was based on an agreement between the estate and the corporation rather than being based on an appraised value as contemplated under the buy-sell agreement.[7] This value, as stipulated by the parties, represented the value of the company without considering the value of death benefits.[8]


Binding the IRS to Buy-Sell Valuation: IRC § 2703

The court initially tackled whether the IRS could be bound to the valuation set in the buy-sell agreement. For a buy-sell agreement to control value, a list of requirements must be met some of which are statutory[9] and others of which are imposed by case law.[10] Those requirements are that the buy-sell agreement must:

  1. Be a bona fide business arrangement;
  2. Not be a device to transfer property to members of the decedent’s family for less than full and adequate consideration in money or money’s worth;
  3. Contain terms that are comparable to similar arrangements entered into by persons in arms’ length transactions;
  4. Contain a purchase price that is fixed and determinable under the agreement;
  5. Be legally binding during life and after death; and
  6. Have been entered into for a bona fide business reason and not be a substitute for testamentary disposition for full and adequate consideration.

If all these requirements are met, then the IRS will be bound by the valuation set forth in a buy-sell agreement. Failing to satisfy even one of these requirements means that the IRS can adjust the valuation determined under a buy-sell agreement to fair market value under standard estate tax principals.[11]

While the court analyzed each of these requirements, having found that the life insurance death benefits should be included in the value of the corporation, the court agreed with the IRS that the $3 million purchase price represented a device to pass wealth to family for less than full and adequate consideration. As a result, the IRS was not bound by the value of the redemption received by the estate. Rather, the IRS was free to argue for a higher value of the business.

In discussing the issues, the court discussed certain important issues under IRC § 2703, including:

  • Preserving a business with family can serve as a bona fide business arrangement;[12]
  • The impact (i.e. importance) of discounts and premiums that should be applied based on whether the interests being purchased represent a controlling or minority interest;
  • Extra scrutiny that will be placed on intra-family transactions;
  • The need for proof of comparable arrangements in arms-length situations; and
  • The importance of complying with the terms of the buy-sell agreement.[13]

Ultimately, the court’s appears to have reached its conclusion by determining that life-insurance death benefits should be includable in the value of the corporation. Once that determination was made, it was easy for the court to determine that the arrangement was a device to transfer wealth for less than full and adequate consideration. The parties did themselves no favors by not complying with the terms of the buy-sell agreement or documenting the change as a modification.[14]

Fair Market Value: Inclusion of Life Insurance Death Benefits

Having determined that the IRS is not bound by the buy-sell price paid to the estate, the court went on to discuss valuation. Since the parties stipulated to a value without addition of life insurance death benefits, the singular issue for the court to address was whether those death benefits should be included in the corporation’s value (as a matter of law, the case having been determined on summary judgment). This issue has been previously addressed by the Tax Court and the Eleventh Circuit Court of Appeals in Estate of Blount.[15] There, the Tax Court found that life insurance death benefits payable to the corporation on the death of a shareholder to be redeemed under a buy-sell agreement should be included in valuing the corporation. The Eleventh Circuit disagreed and overturned the Tax Court. Connelly is appealable to the Eighth Circuit which means a different result is possible than in Estate of Blount.

The primary argument relied upon in Estate of Blount and, thus, the estate in Connelly is that the redemption obligation of the buy-sell agreement serves as a liability offsetting the value of any death benefits that must be used to fund the redemption. As such, even if the death benefits are included in valuing the corporation, that has no real effect on value due to the corresponding liability.

In Connelly, the court disagreed with the Eleventh Circuit. Instead, the court relied on the Tax Court’s reasoning to include death benefits in the value of the corporation. The court discussed its reasoning as follows:

The willing buyer would not factor the company’s redemption obligation into the value of the company, because with the purchase of the entire company, the buyer would thereby acquire all of the shares that would be redeemed under the redemption obligation; in other words the buyer would pay all of the shareholders the fair market value for all of their shares. The company, under the buyer’s new ownership, would then be obligated to redeem shares that the buyer now holds. Since the buyer would receive the payment from the stock redemption, the buyer would not consider the obligation to himself as a liability that lowers the value of the company to him. See Estate of Blount, 2004 WL 1059517, at *25 (T.C. 2004) (“To treat the corporation’s obligation to redeem the very shares that are being valued as a liability that reduces the value of the corporate entity thus distorts the nature of the ownership interest represented by those shares.”).

A willing buyer purchasing Crown C on the date of Michael’s death would not demand a reduced purchase price because of the redemption obligation in the Stock Agreement, as Crown C’s fair market value would remain the same regardless. The willing buyer would buy all 500 of Crown C’s outstanding shares (from Michael’s Estate and Thomas) for $6.86 million, acquiring Crown C’s $3.86 million in estimated value plus the $3 million in life-insurance proceeds at issue. If Crown C had no redemption obligation, the willing buyer would then own 100% of a company worth $6.86 million.

But even with a redemption obligation, Crown C’s fair market value remains the same. Once the buyer owned Crown C outright, the buyer could either: 1) cancel the redemption obligation to himself and own 100% of a company worth $6.86 million, or 2) let Crown C redeem Michael’s former shares––the buyer (and not Michael’s Estate) would receive roughly $5.3 million in cash and then own 100% of a company worth the remaining value of about $1.56 million, leaving the buyer with a total of $6.86 million in assets. Therefore, with or without the redemption obligation, the fair market value of Crown C on the date of Michael’s death was $6.86 million.

In addition, the court went on to discuss the issue under similar logic, but phrased differently as follows:

Demonstrating this point, exclusion of the insurance proceeds from the fair market value of Crown C and valuing Michael’s shares at $3 million results in drastically different share prices for Michael’s shares compared to Thomas’s. If on the date of his death, Michael’s 77.18% interest was worth only $3 million ($7,774/share), that would make Thomas’s 22.82% interest worth $3.86 million ($33,863/share) because Thomas owned all other outstanding shares and the residual value of Crown C was $3.86 million. See Doc. 53-19 at ¶ 61. The residual value of Crown C is the value of the company apart from the $3 million of insurance proceeds at issue. The parties have agreed that this value was $3.8 million. Doc. 48 at ¶¶ 1–3; Doc. 58 at ¶¶ 43, 79–81. Because Thomas was the only other shareholder of Crown C, his ownership interest must therefore equal the residual value of Crown C: $3.8 million. This outcome violates customary valuation principles because Thomas’s shares would be worth 336% more than Michael’s at the exact same time. See Doc. 53-19 at ¶ 61. A willing seller of Michael’s shares would not accept this bargain, as it creates a windfall for the buyer (Crown C of which Thomas would now have 100% control), while undervaluing Michael’s shares in comparison.

Based on this reasoning, the court included the value of death benefits payable to the corporation in determining the value of the estate’s interest in the business. The consequence is that the estate received a $3 million redemption payment, but ends up paying estate tax on a larger value.[16]


This case is appealable to the Eighth Circuit Court of Appeals. It certainly is possible that the Eight Circuit may overrule the trial court and reach a conclusion similar to Estate of Blount. If, however, this result stands, it serves as a warning to taxpayers and their advisors in structuring buy-sell agreements.

It is extremely common for closely-held business owners to enter into buy-sell agreements which set forth terms for the acquisition of a deceased owner’s interests at death. Not only is this common, but highly advisable. In those arrangements, it is also common to fund the purchase with life insurance, that the business owners may not strictly adhere to the agreement’s written terms, and that valuation does not include discounts/premiums based on percentage ownership. Here, while the court had a lot to say about lack of adherence to the agreement’s terms and also mentioned the lack of discounts/premiums, it seems obvious from reading the opinion that the real issue was whether life insurance death benefits should be included in value. Once that was determined, the result was a foregone conclusion.

Given this outcome, what are business owners to do? Without knowing what the Eight Circuit Court of Appeals may do with this case, and knowing that neither the Eight Circuit nor the Eleventh Circuit may have the last say, it seems that buy-sell arrangements should not be funded through redemption life insurance (at least outside of the Eleventh Circuit where Estate of Blount should control). Instead, where life insurance is desirable to fund the plan, the buy-sell agreement should be structured as a cross-purchase agreement. Under such an arrangement, each owner owns life insurance on the other(s). The death benefits payable to surviving owners are used to purchase interests from a deceased owner rather than adding death benefits to the business, thereby possibly increasing the value of the business in the deceased owner’s estate.

Notwithstanding the court’s discussion in Connelly, it is hard to see why a cross-purchase structure should result in a different value to the parties than a redemption agreement. Ultimately, while the structures are different, the results are essentially the same. It will be interesting to see how these issues develop. However, for now, the Connelly case highlights how care should be taken to avoid a valuation whipsaw by paying estate tax on a business value in excess of the cash actually received under a buy-sell agreement.

[1] Connelly v. Dep’t of Treasury, 2021 WL 4281288

[2] The estate’s interest in the business was 77.18%.

[3] Connelly, 2021 WL 4281288, at *2

[4] Id.

[5] Id.

[6] Id.

[7] Connelly, 2021 WL 4281288, at *3

[8] Id.

[9] IRC § 2703(b)

[10] Estate of True v. Comm’r, 390 F.3d 1210 (10th Cir. 2004) and St. Louis County Bank, 674 F.2d 1207 (8th Cir. 1982).

[11] See IRC §§ 2031(a) and 2033 and Treas. Reg. § 20.2031-1(b).

[12] Citing St. Louis City Bank, 674 F.2d at 1210; Estate of Lauder v. Comm’r, T.C. Memo 1992-736; and Estate of Gloeckner v. Comm’r, 152 F.3d 208, 214 (2nd Cir. 1998).

[13] The court made much to do about the fact that no Certificate of Agreed Value was ever executed and the requirement for an appraisal in lieu of such Certificate was not obtained. Rather, the estate and the corporation agreed to a price without requiring strict adherence to the terms of the agreement.

[14] See the court’s discussion of Estate of Lauder where deviation from the agreement’s terms was not fatal but the fact that the family executed formal waivers and modifications indicated that they treated the agreement as binding.

[15] Estate of Blount, 428 F.3d 1338 (11th Cir. 2005).

[16] Note that this is at least the second case in 2021 where a taxpayer was whipsawed by valuations. In Estate of Warne, T.C. Memo 2021-17, a taxable estate included the full value of business interests but was required to discount fractional interests passing to charities even though 100% of the entity was donated, but among multiple charitable recipients. The result was that 100% passed to charity, but the charitable deduction was less than 100% of the value included on the estate tax return. For more details see the article by Devin Mills, “Warne Case gives Insight on Valuation and Gifting”, March 3, 2021, https://esapllc.com/warne-2021/ and the article by Charles J. Allen, “Estate Tax Charitable Deduction Limited to Value of Property Received by Charity” which discuses a similar result from Dieringer v. Comm. 123 AFTR 2019-500 (9th Cir. 2019) affirming Estate of Dieringer, 146 TC 117 (2016).March 29, 2019, https://esapllc.com/dieringer-9th/.


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