Details Matter

Do you and your business partners have a buy-sell agreement? If so, do you pay attention to its requirements? The U.S. Supreme Court recently heard arguments in Connelly v. Internal Revenue Service, a dispute over the value of a closely-held corporation following the death of a shareholder. So far, the IRS has prevailed at both the trial and appellate levels.

The Connelly brothers, Michael and Thomas, co-owned a business. They entered into a buy-sell agreement like many business owners, and the corporation purchased life insurance so it could buy back the shares of the first brother to die. The buy-sell agreement required the brothers to annually agree on the value of the corporation. Failing that, they were to obtain two or more appraisals. Sadly, neither was done, even after the death of brother Michael.

Instead, family members agreed among themselves that Michael’s shares were worth $3 million. They did not count the $3 million in life insurance proceeds as a business asset in their valuation because those funds were required to be spent for the repurchase of Michael’s stock. Michael’s shares were repurchased, and an estate tax return was filed.

The IRS rejected the estate’s valuation of the business, assessing more than $1 million in estate tax beyond what the family was expecting. Michael’s estate paid the tax, then sued for a refund. The lower courts sided with the IRS, concluding that (1) the life insurance death benefit was a company asset and, therefore, must be included in establishing the corporation’s value; (2) the buy-sell agreement failed to include a formula or measure sufficient to determine share price; and, of course, (3) the appraisal requirement was ignored.

The Supreme Court has not yet issued its opinion, but it has been reported that the justices seemed to favor the IRS at oral argument. We will keep you posted; in the meantime, we encourage you to have your buy-sell arrangements reviewed to ensure that they pass muster, and that you have been complying with their requirements. You can reach a Wright Beamer business attorney at (248) 477-6300.