BUSINESS VALUATIONS: SCOTUS’ $700,000 TAX SCARE COULD SHOCK SMALLER BUSINESSES
In the Estate of Connelly, the U.S. Supreme Court okayed a 4 million dollar add-on to the value of an estate due to sloppy management of a business buy-sell (stock redemption) agreement that applied at the death of the taxpayer.
The agreement provided a buyout value of $3 million and the company owned a $3 million life insurance policy on the life of the deceased. The traditional understanding was that a life insurance policy payable on the death of a stockholder was not included in the business valuation if the buyout value was specifically stated in a stock purchase agreement effective at death. The IRS valued the business at $3.8 million and added the $3 million life insurance proceeds to bring the valuation to nearly $7 million.
The Connelly case highlights the critical importance of federal estate tax vis à vis the valuation ofa business. The failure to manage the stock redemption agreement with regular business valuations cost Connelly $700,000.
Today an estate faces federal estate tax when the taxable estate value exceeds $13.6 million. This is scheduled to drop significantly in 2026 to about half that amount.
While many smaller businesses will not reach the federal estate tax value, many states have estate and inheritance taxes that apply to much lower values. In Massachusetts, for example, the floor is essentially $2 million when credits are considered.
While the “shock” number of the Connelly case got the publicity, the reasoning behind the SCOTUS’ finding was pegged to the fact that the shareholders in the corporation had not followed the process required by the stock redemption agreement that governed the transaction. For many years, the shareholders had not met to consider the terms of the agreement or whether the value of the corporation should be changed due to such things as the performance of the business or the state of the economy.
One wonders if state taxing authorities will pick up on this reasoning and go behind the terms of a stock purchase agreement in order to change the estate or inheritance tax liability based on failure to adhere to the redemption agreement. Could the rationale go beyond the life insurance question to valuation in general?
Is the solution simple? While this is still green territory, it makes sense that a stock purchase agreement provides for periodic review by the shareholders with an eye to whether the valuation of shares is appropriate – whether a fixed amount or formula. A vote of the shareholders affirming the decisions should be made part of the corporate documentation. The issue may not be limited to just corporations.
If you need support for establishing a process and generating periodic valuations, contact Barry N. Koslow, JD at Secure Benefits Northeast, LLC. 781-724-6695, barry.koslow@secbenne.com.