SCOTUS Also Adds When It Should Subtract – So Check Every Buy-Sell Out There

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We’re all familiar with the old brainteaser:  Three men check into a hotel and pay $10 each for a $30 room.  The owner later decides to give them a discount and sends the bellhop back with a $5 refund.  But he only returns $1 to each guest and pockets the other $2.

Question:  So… if the guests ended up paying only $27 ($9 each) and the bellboy kept $2, the total is $29.  What happened to the other dollar from the original $30?  Answer:  We’re adding when we should be subtracting.  From the initial $30 subtract the $3 refund.  Then from the remaining $27 subtract the $2 scarfed by the purloining porter leaving the remaining $25 that is down in the till at the front desk.

The Supreme Court kinda did the same thing in the case of Connelly v. U.S (that we have discussed before).  In a nutshell, the high-net-worth Connelly brothers owned a building supply company and agreed that when either of them died the company would redeem the deceased’s interest at an agreed price.  The company owned life insurance on each to fund the redemption.

Since, at least, the discovery of the New World, all have agreed that valuing a business for estate tax purposes under an insurance-funded redemption agreement meant off-setting the amount of incoming death proceeds by the amount of company’s redemption obligation. 

But all nine of the Justices added when they should have subtracted by including the death benefits in the business’s FMV, ignoring any valuation counterbalance by the obligation to redeem.  And it cost the wealthy Connelly family significantly.

Despite the poor reasoning of the Court, the ruling had extremely limited adverse effect because:
  • It only has estate tax consequences for super-high-net worth business owners (given the permanent $15,000,000 lifetime exemption under the One, Big, Beautiful Bill).
  • And then only if the taxpayer has a buy-sell agreement in place with a redemption format (vs. a cross-purchase structure).
  • And then only if it is funded with business-owned life insurance.

Nonetheless, the decision serves as a good conversation starter for follow-up with every client or prospect with a business interest.  The fact is that many businesses have not done sufficient buy-sell planning and many that have 1) have not updated them recently, and/or 2) have not funded them properly, and/or 3) have redemption-type agreements which are usually not the best way, regardless of any Supreme Court rulings.

Call to discuss any buy-sell case planning questions or to plan a conference or Zoom call with your client and/or their advisors concerning steps they should consider with you – Tom Virkler at 706-614-3796 or tom@cpsadvancedmarkets.com.

For What It’s Worth:  Speaking of popular math questions – If all we knew about the Connelly siblings was that there was only two and that one of them was male, what would have been the odds that the other was also a male?