Connelly vs United States and Succession Planning

The recent Connelly v. United States Supreme Court decision provides critical insight for closely held business owners considering succession planning and tax implications.

The Court's ruling clarifies that life insurance proceeds owned by a corporation, even if intended for share repurchase agreements, increase the corporation's value for estate tax purposes. This decision impacts business owners who use corporate-owned life insurance as part of their succession planning, as it reaffirms that the company's obligations to redeem shares do not reduce the company's valuation in terms of tax liability.

Key Takeaways from Connelly v. United States

1. Business Value Impact: Life insurance proceeds payable to the corporation increase the corporation's valuation, which affects the value of shares for estate tax calculations. In Connelly's case, the $3 million policy proceeds were added to the company's value upon Michael's death, which led to a substantial tax bill.

2. Planning Options: The Court suggested alternative structures, like a cross-purchase agreement where individual shareholders own policies on each other. This setup may avoid increasing the corporation's value upon a shareholder's death, potentially reducing estate tax exposure.

3. Professional Advisory Importance: This case underscores the value of consulting with tax professionals, insurance experts, and succession planners to design strategies that align with tax laws, which can help mitigate unexpected financial consequences.

Practical Steps for Business Owners

• Coordinate with your Advisory Team: Using a coordinated approach with legal, tax, and insurance professionals can ensure strategies align with tax regulations, reducing the risk of unintended tax liabilities.

• Consider Cross-Purchase Agreements: Cross-purchase agreements may provide tax advantages over corporate-owned life insurance policies for some businesses.

Connelly v. United States offers a valuable lesson in how business structure and tax planning interact. Proactively structuring ownership transitions could avoid similar tax outcomes, enabling smoother family business successions and a more straightforward path for future growth.

Contact us today for assistance in reviewing your current agreement: 301-859-0860 | email@ennislp.com.

"I want to sell my business in the next 1-2 years..."

Many baby boomer business owners are thinking they "are ready" to leave their business in next 1-2 years and begin their retirement or third act in life.  With the economy growing and the number of investors seeking quality businesses to buy, many are thinking it could be an opportunity to "sell high" and accomplish their financial goals.

If indeed there is a desire is to sell within 2 years, and minimal or no exit planning and pre-sale due diligence has been achieved to this point, following are a number of the key planning issues that should be addressed in the first 60 days:

• Establish owner-based exit goals (desired buyer, sale-price, values-based goals, etc.) and do whatever possible to prepare for life after the sale. Survey data indicates most business owners are not happy in life two years after the sale of their business.

• Select a transaction intermediary (Investment Banker or Business Broker).

• Get an estimate of business marketability and value.

• Begin tax planning and pre-sale due diligence.

• Assess and, if possible, enhance business value drivers.

• Take steps to protect the value of the business during transfer (i.e., employee incentive plans/stay bonus).

• Select the remaining needed members of your Deal Team (i.e., CPA, M&A Attorney).

• Review your estate plan and business continuity arrangements.

• Make decisions pertaining to a plan for communicating your plans to employees.

This is not an exhaustive list and only represents what should happen in the first 60 days.  There is much more to do throughout the 2-year period to give yourself the best chance at a successful exit.  So, an immediate priority should be the selection of a trained and experienced Exit Planner to assist with the management of the exit planning project.  Typically someone is going to engage a knowledgeable project manager or general contractor to manage the process for building their "dream house".  In selling a business, there is much more at stake than building a dream house.

Invest 12-15 minutes in the FREE ExitMap® Assessment and get a 12-page report scoring you in four key exit planning areas: Finance, Planning, Revenue/Profit, and Operations.

What is a Certified Business Valuation and When Do I Need One?

A Certified Business Valuation is a comprehensive assessment conducted by a qualified professional to determine the fair market value of a business. It involves a systematic analysis of various factors such as financial statements, industry trends, market conditions, company assets, intellectual property, customer base, and other relevant aspects to estimate the worth of a business.

You may need a Certified Business Valuation in several situations, including:

• Selling or Buying a Business: When you're involved in a business sale or acquisition, a valuation helps determine a fair asking price or offer, ensuring both parties understand the business's value.

• Obtaining Financing: When seeking a loan or financing for your business, lenders often require a valuation to assess the value of the company and its ability to generate cash flow to repay the loan.

• Partnership Dissolution: If you're part of a dissolving business partnership, a valuation is essential to determine the fair value of each partner's share and facilitate a smooth division of assets.

• Estate Planning: Business valuations are necessary when planning for estate taxes or distributing business assets as part of an inheritance. A valuation helps establish the value of the business for tax purposes and ensures a fair distribution among beneficiaries.

• Shareholder Disputes: In case of disagreements among shareholders, a valuation can be conducted to determine the value of shares or ownership interests, aiding in resolving disputes or facilitating a buyout.

• Financial Reporting: Valuations may be required for financial reporting purposes, such as complying with accounting standards or fulfilling regulatory requirements.

• Litigation or Dispute Resolution: During legal proceedings like divorce settlements, bankruptcy, or insurance claims, a certified valuation can provide an objective assessment of the business's value, serving as evidence in court.

It's important to note that the specific circumstances and requirements for a Certified Business Valuation may vary based on jurisdiction and the purpose for which it is being conducted. Consulting with a qualified business valuator or professional accountant can help you determine when and how to obtain a valuation tailored to your needs.

Invest 12-15 minutes in the FREE ExitMap® Assessment and get a 12-page report scoring you in four key exit planning areas: Finance, Planning, Revenue/Profit, and Operations.

The Achilles Heel of Wealth Planning for Business Owners

Small to mid-sized business owners pour themselves into building a valuable business, and if they have a retirement strategy, it likely includes “selling the business”. 

Many business owners have a Wealth Advisor who diligently seeks to ensure the owner has a plan for that “Next Act” – when they sell the business.  And as I speak to Wealth Advisors, a common data point is that for the majority of Business Owners,  the business is often a major portion (80%+) of their portfolio.  So,  the retirement plan is:

1.     Run the business and invest in your 401K and

2.     Sell the business to fund retirement.

Yet – there is an Achille’s Heel to this plan.  

When asked how the value of the business was determined, advisors often say “The Owner told me the number”.   And when we dig a little deeper, that value the owner passes on is often not based on an outside valuation/estimate but on conventional wisdom, hearsay, their friend’s business, or a simple gut feel.  A full 80% of the Wealth Advisor’s planning is not based on objective data, but on a gut feel!  Unfortunately, if that gut feeling is wrong, it can be too late to correct it. 

Basic Exit Planning is a key to protecting against this threat and ensuring that plans are based on reality.  Several key facets of Exit Planning support sound wealth planning, including:

1.     Establishing business value through a 3rd party analysis through a formal valuation or estimate of value.  This gives an objective number for planning.

2.     Assessment of business quality – giving an objective sense of whether the business is sellable.

3.     Plan for value creation – if there is a value deficiency, exit planning focuses on enhancing business value, including correcting weaknesses and planning for growth.

4.     Clarification of Exit Options allowing an owner to understand and choose an optimal exit path that maximizes the ability to meet financial and non-financial goals

5.     Coordination with Wealth Advisor, Tax Advisors, and other professionals to develop tax-efficient strategies for wealth planning, as well as plans to accrue wealth prior to sale.

6.     And perhaps most importantly, clarity of the reality of the situation.  If the news is bad, at least it isn’t a surprise and plans can be made accordingly.

We recommend:

1.     Team up with a wealth advisor who routinely works with business owners and understands your unique challenges.

2.     Establish the value of your business with a 3rd party estimate of value/valuation.

3.     Consult an Exit Planner to understand your exit options.  

4.     Consult your CPA to understand the tax implications of those options.

5.     Work with your advisors to accrue wealth while you own the business. 

Invest 12-15 minutes today in the FREE ExitMap® Assessment and get a 12-page report scoring you in four key exit planning areas: Finance, Planning, Revenue/Profit, and Operations.