The Connelly Ruling
However, as the Connelly case illustrates, the IRS’s treatment of life insurance proceeds can have significant tax implications.
The Supreme Court’s ruling in Connelly affirmed that life insurance proceeds, when used to fund a redemption obligation, do not reduce the value of the business for estate tax purposes.
For LLC owners, this means that the proceeds from a life insurance policy could increase the taxable value of the business, potentially leading to a higher estate tax liability.
To safeguard a client’s LLC from these unexpected tax consequences, work closely with a tax professional who can help the client use these best practices:
Review and update buy-sell agreements: Ensure that the client’s buy-sell agreements are up-to-date and reflect the current legal landscape, including the implications of the Connelly ruling. Business owners should be reviewing these agreements now in the light of Connelly and, in the future, every three to five years.
Consult with advisors: A business owner client should work closely with legal and tax advisors to understand how the IRS may treat life insurance proceeds within the client’s LLC structure. You, the tax advisors and the client should work together to develop strategies to mitigate potential estate tax liabilities.
Plan for liquidity: A business owner client should ensure that the LLC has enough liquidity to cover potential tax liabilities without disrupting business operations. This may involve setting aside additional funds or exploring options for deferring estate taxes.
The Connelly decision serves as a reminder of the complexities involved in insurance planning within an LLC.
Your business owner clients are responsible for ensuring their planning strategies not only protect their businesses but also minimize the risk of unintended tax consequences.
By taking a proactive approach and regularly reviewing insurance arrangements, those clients owners can safeguard their LLCs’ future and provide peace of mind for all stakeholders.
The U.S. Supreme Court building in Washington, D.C. Credit: Bloomberg
Jack Elder is senior vice president of advanced markets at CBS Brokerage.