Supreme Court Ruling Won’t Answer Key Estate Valuation Questions

On the surface, the issue before the US Supreme Court in Connelly v. IRS appears to be simply about whether life-insurance proceeds should be included in the value of a decedent’s company for tax purposes. On closer examination, the issue is more complex, and many questions will remain unanswered no matter how the court rules.

The case seemingly centers on a single valuation issue. A closely held corporation took out proceeds of a life-insurance policy to facilitate the redemption of the shareholder’s stock. The question is whether that should be considered a corporate asset when calculating the value of the shareholder’s shares for federal estate tax purposes.

The taxpayer contends the life-insurance proceeds should be excluded, thereby lowering the value of the decedent’s shares and lowering the tax owed. The IRS disagreed and assessed additional estate taxes of over $1 million. The US Court of Appeals of the Eighth Circuit upheld a district court’s ruling siding with the IRS. The Supreme Court heard arguments March 27.

The case raises issues that none of the courts have directly addressed.

It’s unclear whether a valuation should factor in the death of a decedent. An old dilemma that valuation practitioners face is determining the exact timing of the valuation—is it the moment prior to death, the moment of death, or the moment after death?

While this may sound like an insignificant difference, the implications are profound. If the valuation took place before or at the moment of death (and, presumably, death is a somewhat unpredictable event), there could be no expectation of an immediate payout of life-insurance proceeds.

If the valuation happened after the death (as the as the district court and Eighth Circuit courts implied by their rulings, which was intended to be in line with but actually contradicts a ruling by the Fifth Circuit), then perhaps other factors resulting from the death should be considered. For instance, if most or all customer relationships were with the decedent, should the potential loss of such customers be factored into the valuation?

It’s also unclear whether the age and health of the insured should matter in the analysis. If there is presumed value of other life insurance policies held by the company (in Connelly, there was a second life-insurance policy on the other brother), does this increase the value of the company in some way?

On that note, the courts in Connelly only ever considered whether the life insurance proceeds—the death benefit—should be included in the value of the company. No consideration was made whether another measure of value (such as cash surrender value, interpolated terminal reserve value) should be considered instead.

The life insurance proceeds in Connelly were $3.5 million, but only the $3 million used for the redemption seems to have been added back to the value. Does the omission of $500,000 imply that proceeds not used for redemption should be ignored, or was it simply an omission?

Another question concerns whether this case truly addresses the issue of inclusion of life-insurance proceeds (as all three courts seem to think) or the issue of including redemption obligations instead? This point may seem trivial, but if a company is the beneficiary of a life-insurance policy but doesn’t have a corresponding redemption obligation, it’s unclear whether the value needs to be included.

Many decisions that affect an estate’s value, such as the timing of a valuation or which value to use for the life insurance policy, represent legal issues or could be interpreted as such. Appraisers should seek input of the estate planner or litigator when facing these unanswered questions.

The case is Connelly v. United States, U.S., No. 23-146, oral argument 3/27/24.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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Oliver Warnke is managing director at Stout.

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