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Thursday, June 13, 2024 | Back issues
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IRS can tax death benefits used to purchase stocks, high court rules

The justices said the IRS could seek an additional $1 million for the death benefits used in a stock handoff deal.

WASHINGTON (CN) — The government can claim more in estate taxes from certain stock handoffs after a shareholder dies after a unanimous Supreme Court ruling on Thursday.

Contractual agreements to purchase shares of deceased CEOs do not diminish the value of those shares, the court determined, and the value of those shares in a closely held corporation must reflect the corporation’s fair market value when calculating the federal estate tax.

The ruling prohibits companies from deducting a contract agreement to buy a CEO’s shares from life insurance proceeds. 

“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,” Justice Clarence Thomas wrote for the majority.

In the underlying case, roofing company Crown C Supply Company agreed to buy the stock of CEO Michael Connelly upon his death. Connelly owned almost 80% of the company’s shares, and the buy-sell agreement guaranteed ownership continuity in the corporation.

Crown Supply took out a life insurance policy on Connelly after making this agreement. When Connelly died in 2012, the company received $3.5 million in death benefit proceeds. Crown used $3 million of that money to buy Connelly’s stock, which was valued at $3 million.

Connelly’s estate listed the $3 million stock on its 2014 estate tax return. During an audit, the Internal Revenue Service claimed Connelly’s stock was worth $5.3 million. The difference between the two evaluations was a result of the government included a percentage of the death benefit proceeds in the stock’s value. The IRS’ valuation left Connelly’s estate with an additional $1 million in estate taxes.

Two lower courts ruled in favor of the IRS, and the Supreme Court agreed to decide whether the death benefits proceeds should have been included or not.

The justices agreed with the IRS that the death benefits should have been included. The court said no real-world buyer or seller would have viewed the redemption obligation as an offsetting liability. 

“Because a fair-market-value redemption has no effect on any shareholder’s economic interest, no willing buyer purchasing Michael’s shares would have treated Crown’s obligation to redeem Michael’s shares at fair market value as a factor that reduced the value of those shares,” Thomas wrote. 

The George H. W. Bush appointee acknowledged concerns that this conclusion would make succession planning more difficult for closely held corporations. Thomas said this may be the case, but that was the choice of the Connelly brothers. 

"By opting to have Crown purchase the life-insurance policies and pay the premiums, the Connelly brothers guaranteed that the policies would remain in force and that the insurance proceeds would be available to fund the redemption,” Thomas wrote. “As we have explained, however, this arrangement also meant that Crown would receive the proceeds and thereby increase the value of Michael’s shares.” 

Follow @KelseyReichmann
Categories / Appeals, Courts, Financial

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