Your Buy/Sell Agreement Could Be a Ticking Time Bomb...A Cautionary Tale

A buy-sell agreement funded with life insurance decides, in advance, what happens to an owner's share of a business when a triggering event occurs, such as death, disability, or retirement. Funded correctly, it gives the remaining owners the cash to buy that share and gives the departing owner's family fair value without forcing a fire sale. Funded or structured carelessly, it can backfire. A 2024 Supreme Court decision, Connelly v. United States, showed exactly how, and it is the reason every business owner who has one of these agreements should get it reviewed.

September is Life Insurance Awareness Month, which makes it a fitting time for owners of family businesses across Alpena, Gaylord, and the rest of northern Michigan to pull their agreement out of the drawer and read it again. Many were signed years ago and never revisited.

What does a funded buy-sell agreement actually do?

A buy-sell agreement is a legally binding contract among business owners that sets the terms for transferring an owner's interest. When it is funded with life insurance, the death benefit provides the money to complete the purchase at exactly the moment the business can least afford a cash crunch. A well-built agreement generally accomplishes several things at once:

1. Keeps the business running by giving the remaining owners the means to buy a departing owner's share
2. Provides fair value to a departing owner or their heirs
3. Prevents an unplanned heir from becoming an unwanted co-owner
4. Sets an agreed method for valuing the business, which heads off disputes
5. Creates liquidity through a death benefit that is generally income-tax-free
6. Spares the surviving owners from selling assets or taking on debt to fund a buyout
7. Signals financial stability to lenders and bonding companies
8. Gives a retiring owner a clear exit and lets everyone stay focused on the business

These agreements are a natural companion to life insurance and to the broader business owners insurance that protects the company itself.

What did Connelly v. United States change?

On June 6, 2024, the Supreme Court ruled unanimously in Connelly v. United States (U.S. Supreme Court opinion). The Court sided with the IRS and held that life insurance proceeds a company receives to redeem a deceased owner's shares do not reduce the company's value for federal estate-tax purposes. In plain terms, the money set aside to buy the shares can increase the reported value of the business, which can increase the estate-tax exposure of the owner who died.

How did the Connelly case play out?

The case involved two brothers, Michael and Thomas Connelly, who owned a building supply company and used a redemption arrangement to keep it in the family. When Michael died:

• The company received about $3 million in life insurance proceeds
• Thomas did not personally buy the shares, so the company was obligated to redeem them
• The IRS added the $3 million death benefit to the company's value rather than treating it as offset by the redemption obligation
• Michael's taxable estate rose accordingly, producing a larger federal estate-tax bill than the family expected

The brothers had done real planning. It was the structure, not the intent, that created the surprise.

What does this mean for a Michigan business owner?

The lesson is not that life insurance is the problem. It is that the structure of the agreement, and who owns the policy, matter enormously. A few takeaways:

• There is no one-size-fits-all agreement. Structure has to fit your ownership, your entity type, and your goals
• A cross-purchase structure, where owners buy policies on one another, is treated differently than a company redemption. Which one fits is a question for your advisors
• Estate-tax thresholds are set by federal law and adjusted over time by the IRS, and they have changed recently, so whether your business is anywhere near the threshold is worth confirming with your tax professional (IRS estate tax)
• An agreement written years ago may no longer match current law or your current valuation

What should you review, and with whom?

A buy-sell review is a team activity. Your attorney handles the legal structure, your CPA addresses the tax questions, and your insurance agent makes sure the funding actually matches the obligation. Before that meeting, gather:

• Your current buy-sell agreement and the date it was last updated
• A recent, realistic valuation of the business
• The life insurance policies funding the agreement, including who owns them and who the beneficiary is
• Your current ownership breakdown and any changes since the agreement was signed
• A note of any triggering events you want covered beyond death, such as disability or divorce

Any coverage discussion is subject to underwriting, and nothing is bound or altered until confirmed by an authorized representative.

When was the last time someone reviewed your buy-sell agreement? For a lot of northern Michigan business owners, the honest answer is longer ago than it should be. If you would like an agent who works with these arrangements to sit down with you and your other advisors, call Top O' Michigan at 800-686-8664, visit our Alpena office, or email Service@TheSpireTeam.com. You may also find our posts on how much liability coverage is enough and how we shop the market for clients useful, or see how we serve local businesses on our locations page.