Buy-Sell Agreement Funding After Connelly: What Maryland Business Owners Need to Revisit
If you own a business with partners and you have a buy-sell agreement funded by life insurance, there is a reasonable chance it was written before June 2024 and has not been looked at since. That is the problem. A unanimous Supreme Court decision that month changed the arithmetic underneath a very common structure, and for business owners in Maryland the consequences arrive sooner than they do almost anywhere else.
This is not a reason to panic. It is a reason to get the agreement off the shelf.
Key takeaways
- There are two common ways to fund a buy-sell. In a cross purchase, the owners insure each other. In an entity redemption, the company owns the policies and buys back the shares.
- In Connelly v. United States, decided unanimously in June 2024, the Supreme Court held that life insurance proceeds a company receives to fund a redemption increase the value of the company for estate tax purposes, and the obligation to redeem does not offset them.
- In that case, shares the estate valued at 3 million dollars were valued at roughly 5.3 million dollars instead.
- Maryland taxes estates above 5 million dollars, a threshold unchanged since 2019 and not indexed for inflation. A valuation swing of this size can move a family from owing nothing to owing a great deal.
- Redemption agreements are not automatically wrong. They just need to be re-examined with open eyes.
The two ways to fund a buy-sell
A buy-sell agreement decides what happens to an ownership stake when an owner dies, leaves or becomes disabled. Without funding it is a promise with no money behind it, which is why life insurance is the usual mechanism.
In a cross purchase, each owner buys a policy on the other. When one dies, the survivor receives the death benefit personally and uses it to buy the shares from the estate. The company is not involved.
In an entity redemption, the company owns and pays for policies on each owner. When one dies, the company collects the proceeds and buys back the shares. This is simpler to administer, especially with more than two or three owners, which is exactly why it became the default.
What Connelly changed
Michael and Thomas Connelly owned Crown C Supply, a building supply business. Michael held 77.18 percent and Thomas held the rest. The company owned a 3.5 million dollar policy on each brother, and their agreement said that if the surviving brother declined to buy the shares, the company would redeem them.
Michael died. Thomas declined. The company used 3 million dollars of the insurance proceeds to redeem Michael shares.
For the estate tax return, the estate and the IRS agreed that setting the insurance aside, the company was worth 3.86 million dollars and Michael stake was worth 3 million. The estate reported that figure, reasoning that the insurance money was earmarked to buy the shares and so was cancelled out by the obligation to pay it.
The IRS disagreed. It said the company was worth 3.86 million plus the 3 million in proceeds, so 6.86 million, which made Michael 77.18 percent worth about 5.3 million rather than 3 million.
The Supreme Court sided with the IRS, unanimously. The reasoning is easier to follow than it sounds: a company buying back shares at fair market value has not made anyone poorer. The remaining owner now holds a smaller company but a larger slice of it. Since no shareholder is worse off economically, the redemption obligation is not a liability that reduces value.
The practical effect is that the insurance you bought to solve a problem became part of the taxable estate.
Why this lands harder in Maryland
At the federal level, exemptions are high enough that most business owners never reach them. Maryland is a different conversation. The Maryland estate tax threshold is 5 million dollars per person. It has not moved since 2019 and it is not indexed for inflation, so every year of business growth and every year of inflation pulls more families toward it.
A valuation swing of two million dollars is not academic at that threshold. It is the difference between an estate that owes nothing to Maryland and one that owes a meaningful sum, payable in cash, at the worst possible moment for the surviving family and the surviving owner.
Washington DC has its own estate tax as well, with its own threshold, which we covered separately.
What owners are actually doing about it
Three responses come up most often, and the right one depends on facts we would need to see.
Switch to a cross purchase. The proceeds go to the surviving owners personally rather than into the company, so they never enter the company valuation. Clean, and it gives the buyer a stepped up basis in the shares they acquire. The drawback is administrative: with four owners you need twelve policies, and the number grows quickly.
Use an insurance LLC or a trust to hold the policies. A separate entity owns the policies and distributes proceeds to the surviving owners, who then buy the shares. This keeps the cross purchase result without the policy count problem. It adds a layer of structure and cost, and it needs to be drafted carefully.
Keep the redemption and plan around it. Sometimes a redemption remains the right structure for operational reasons, and the answer is to size the coverage and the estate plan with the Connelly result built in rather than ignored.
There is no default correct answer here, and anyone who gives you one without reading your agreement is guessing.
The other thing nobody looks at
While the agreement is off the shelf, check the valuation clause. A surprising number of buy-sells set a fixed price per share that was agreed a decade ago and never revisited, or a formula that made sense for a different business. If the agreed price no longer reflects what the company is worth, the insurance is either badly short or the surviving family is selling for far less than the stake is worth.
We also find coverage amounts that were set at the original valuation and never increased, which means a growing business is steadily becoming underinsured against its own success.
Where we fit
We are an insurance brokerage, not a law firm or an accounting firm, and buy-sell restructuring is genuinely collaborative work. Your attorney drafts the agreement and your CPA models the tax. What we bring is the funding side: whether the policies in place match what the agreement actually promises, whether the ownership structure of those policies still makes sense after Connelly, and what it costs to fix. If you do not have an attorney working on this, we can point you toward several in Maryland and DC who do it well.
Nothing here is legal or tax advice, and your own advisors should review your specific situation before you change anything.
Frequently Asked Questions
What is a buy-sell agreement and why does it need funding?
It is a contract among business owners setting out what happens to an ownership stake when an owner dies, becomes disabled or leaves. It usually obliges someone to buy and someone to sell at an agreed price or formula. Without a funding source, that obligation depends on the surviving owners finding a large sum of cash quickly, which is why life insurance is the standard mechanism.
What did the Connelly decision actually change?
It settled that life insurance proceeds received by a company to fund a share redemption count as a company asset for estate tax valuation, and that the obligation to redeem the shares does not offset them. Before the ruling many advisors assumed the two cancelled out. They do not. The Supreme Court decided it unanimously in June 2024.
Does Connelly apply to LLCs and partnerships or only corporations?
The case concerned a corporation. Most commentators expect the reasoning to apply to closely held businesses generally, including LLCs and partnerships, because the logic is about valuation rather than entity type. That is a widely held reading rather than a settled point, so it is worth raising directly with your attorney.
Should we switch from a redemption to a cross purchase agreement?
Possibly, but not automatically. A cross purchase keeps the proceeds out of the company valuation and gives the buying owner a stepped up basis, which are real advantages. It also multiplies the number of policies as owners are added, and switching has its own tax considerations including the transfer for value rules if existing policies change hands. It is a decision to make with your attorney and CPA, not one to make from an article.
Our buy-sell was written years ago. How do we know if it is a problem?
Three quick checks. Who owns the life insurance policies, the company or the individual owners. What the agreement says the shares are worth, and whether that figure still resembles reality. And whether the coverage amount has been increased as the business has grown. If the company owns the policies and the agreement predates June 2024, it is worth a proper review.
Does Maryland have its own estate tax on top of the federal one?
Yes. Maryland taxes estates above 5 million dollars per person, a threshold that has been unchanged since 2019 and is not adjusted for inflation. Because the federal exemption is far higher, business owners here routinely have a Maryland estate tax exposure with no federal one at all, and that is the exposure a Connelly style valuation increase is most likely to trigger.
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