June 06, 2024

Supreme Court Decides Connelly v. United States

On June 6, 2024, the Supreme Court of the United States decided Connelly v. United States, No. 23-146, holding that 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.

Two brothers were the sole shareholders in a closely held corporation. To ensure the corporation would stay in the family if either brother died, the brothers entered into an agreement that gave the surviving brother the option to purchase the deceased brother’s shares. If he declined, the agreement required the corporation itself to redeem the shares. The corporation also took out an insurance policy on each brother to fund the share redemption obligation.

After one brother died, the surviving brother declined to purchase the shares. The corporation received the life insurance proceeds and redeemed the shares, at an agreed-upon price of $3 million. The surviving brother then filed a federal tax return as executor for his deceased brother’s estate in which he reported the value of those shares at the $3 million redemption price.

The IRS audited the estate tax return; and during the audit, the estate obtained a third-party appraisal that valued the shares at $3 million. That number was based on a valuation of the corporation that offset most of the life-insurance proceeds with the cost of redeeming the shares. On an audit of the return, the IRS disagreed, and took the view that the corporation’s redemption obligation was not a liability that reduced the value of the shares. As a result, the IRS valued the corporation (and thereby the shares) at nearly double, which increased the amount of estate tax owed. The estate paid the tax and then sued for a refund. The district court agreed with the government, and the court of appeals affirmed.

The Supreme Court affirmed. It held that the corporation’s contractual obligation to redeem the shares did not diminish the value of those shares. The Court explained that because a fair-market-value redemption does not affect any shareholder’s economic interest, no willing buyer purchasing the deceased brother’s shares would have treated the corporation’s redemption obligation as a factor that reduced the value of those shares. Put another way, when calculating an estate tax, the “whole point” is to assess the value of the shares at the time of death. It “cannot be right,” the Court reasoned, that a corporation would be worth the same or more after it pays out $3 million to redeem shares than it was worth before the redemption.

Justice Thomas delivered the opinion for a unanimous Court.

Download the opinion of the court

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