Buy-Sell Agreements After Connelly: Why Your Company-Owned Policy May Need a Second Look

Most business owners who have a buy-sell agreement signed it years ago and filed it away. It was handled. Then in June 2024 the Supreme Court decided a case about two brothers and a roofing supply company, and a lot of “handled” agreements quietly stopped working the way their owners assumed.

This article explains what a buy-sell is supposed to do, how the funding structures differ, what Connelly changed, and the most common mistake owners make trying to fix it.

What a buy-sell agreement actually does

A buy-sell is a contract among the owners of a closely held business that answers three questions in advance: on what trigger an interest must change hands (death, disability, retirement, divorce, an attempted sale to an outsider), who buys it, and at what price, whether a fixed number, a formula or an appraisal. The attorney writes it.

The fourth question usually goes unwritten: where does the cash come from the morning it triggers? Life insurance is typically the fastest answer, and the only one that arrives in full on day one.

Cross-purchase vs. entity redemption

One fact drives everything else: who owns the policies. In a cross-purchase, each owner personally owns a policy on the others and buys the interest directly. In an entity redemption, the company owns the policies and buys the interest back. A hybrid or “wait-and-see” design gives the company first option, then the surviving owners, so the choice can be made when the trigger actually happens.

That last row is why cross-purchase gets complicated fast: three owners need 6 policies, five need 20. Insurance LLCs and trusteed cross-purchase arrangements exist to deliver cross-purchase economics with one policy per owner. They are designed by the attorney with a carrier’s advanced-markets team, not assembled from a template.

What happened in Connelly v. United States

Brothers Michael and Thomas Connelly owned Crown C Supply, a closely held roofing and siding business. Michael held about 77% of the shares. The company owned a $3.5 million policy on each brother to fund a redemption. When Michael died in 2013, the company used $3 million of the proceeds to redeem his shares, and his estate reported the stock at $3 million.

The IRS valued the company at about $6.86 million: $3.86 million as an operating business plus the $3 million of insurance proceeds. That made Michael’s stake worth roughly $5.3 million and produced an estate-tax deficiency of about $889,914. On June 6, 2024, the Supreme Court unanimously agreed with the IRS: a company’s obligation to redeem shares is not necessarily a liability that reduces its value for estate tax. A buyer of the whole company that day would have paid for the cash in the account.

What Connelly did not change

• It did not outlaw entity-redemption agreements.
• It did not make the death benefit taxable income. Proceeds are generally still received income-tax-free, provided the IRC 101(j) notice-and-consent rules for employer-owned policies were met before issue.
• It changed the default. Company-owned redemption funding is no longer the automatic answer.

Keep the scale honest. Under current law the federal estate tax exclusion is $15 million per person for 2026, so many owners will owe no federal estate tax either way (confirm current figures with your advisor). The valuation logic still matters, because it decides whether the deceased owner’s family is paid what the business was worth, and some states tax estates at much lower thresholds.

The math on a hypothetical $3 million company

Two owners hold a $3 million S-corp 50/50, under an older entity-redemption agreement. The company owns a $1.5 million policy on each. One owner dies. These figures are illustrative only; your CPA applies the real ones.

The family is taxed, where tax applies, on value it never received, and the survivor carries a larger built-in gain if the company is sold later. Same shares, very different landing spots.

The trap in the obvious fix: transfer for value

Owners who read about Connelly often reach for the quick fix: have the company sell each policy to the other owner for its cash value and call it a cross-purchase. That can be an expensive mistake.

Under IRC 101(a)(2), when a policy is transferred for value, the death benefit is generally income-tax-free only up to what the buyer paid plus premiums paid afterward. The rest can be ordinary income. The safe harbors are transfers to:

1. the insured;
2. a partner of the insured;
3. a partnership in which the insured is a partner;
4. a corporation in which the insured is a shareholder or officer;
5. someone whose basis carries over from the transferor, such as a true gift.

A fellow shareholder, individually, is not on that list. In a hypothetical where a co-owner buys a $1.5 million policy from the company for $48,000 and pays $55,200 of premium before the insured dies, only about $103,200 would generally be tax-free and roughly $1,396,800 could be ordinary income.

Safer paths exist, such as transferring a policy to the insured, or forming a properly drafted partnership or LLC among the owners first so each owner is a partner of the insured. Other options include a special-purpose insurance LLC, a hybrid design, or keeping redemption with a valuation formula the owners actually follow. Those are design decisions for your attorney and tax counsel, made before anything is signed.

Your buy-sell self-check

Pull out your agreement and answer five questions:

1. What is the date on it, and when was it last reviewed?
2. Who owns and pays for the policies: the company or the owners?
3. Does the coverage match what the business is worth today?
4. Has the valuation procedure (appraisal or certificate of value) actually been followed?
5. Has any policy ever changed owners, or does anyone plan to move one?

If you can’t answer all five, that is your starting point. The most common findings are that no policy was ever bought, the coverage matches an old valuation, or the funding clause contradicts the buyer clause.

How we approach it

We don’t rewrite your agreement; your attorney does. We read the funding side, put the structures side by side, flag the Connelly and transfer-for-value risks, and fund whatever your attorney and CPA choose. A buy-sell is one of five planning problems most owners carry, and it connects directly to your personal estate plan, covered in the 2026 estate tax and the ILIT. Learn more about our advanced markets work.

Go deeper: how Longtable approaches Business Valuation.