Federal Estate Tax laws require the Internal Revenue Service (“the IRS”) to determine the “fair market value” of every single item in a decedent’s taxable estate.[1] IRS regulations define “fair market value” primarily as the price a willing buyer would be willing to pay and a willing seller would be willing to accept for the item, when neither are under a compulsion to buy or sell, and when all of the facts relevant to the “value” of the item are known to both.[2] However, stock in a corporation that is all privately owned by members of a family often falls outside of that definition, because such stock is often subject to a binding preemption agreement in which the corporation is bound to purchase the stock of a deceased shareholder at a price, or pursuant to a price formula, set by the preemption agreement. The IRS is not bound by that kind of agreement. In Connelly v. United States, decided on June 6, 2024, the Court ruled that the value of a life insurance policy payable to the corporation upon a shareholder’s death, and earmarked for the pay-off of a deceased shareholder’s preemption rights, should usually be included, for Estate Tax purposes, in the IRS’ valuation of the corporation’s stock owned by the decedent at the time of his or her death. The decision of the Court was unanimous.
COMMENT: The Court justified this ruling with the comment that “A hypothetical buyer would thus treat the life-insurance proceeds that would be used to redeem [the deceased shareholder’s] shares as a net asset” of the corporation, completely ignoring the fact that the corporation will realize no financial benefit from the life insurance policy.[3] Its proceeds will all go to the deceased shareholder’s estate, in lieu of any corporate stock. The “hypothetical buyer” imagined by the Court must be either extremely ignorant of the facts, or else extremely stupid as an investor in corporate stock. The true test of the “fair market value” of corporate stock subject to a compulsory preemptive agreement can only be the “net worth” of the corporation as a whole, divided by the number of shares to be sold back to the corporation pursuant to the preemption agreement. In making that calculation, the corporation’s liabilities, at the time of the shareholder’s death, must be subtracted from the value of the corporation’s assets.[4] There may have been other factors not mentioned in the Court’s Opinion that justified the Court’s unanimous result, but the reasoning in the Court’s Opinion can only be described, in a charitable manner, as extraordinarily sloppy.
Dan Rhea
[1] 26 U.S.C. § 2031(a) (only the wealthiest decedents these days have a “taxable estate”).
[2] 26 C.F.R. § 20.2031-1(b).
[3] Connelly v. United States, Sup.Ct. Slip Opinion of June 6, 2024, p. 7.
[4] See 26 C.F.R. § 20.2031-2(f).
RECENT RULINGS 