A recent case brought to light the impact that a stock-purchase agreement and life insurance proceeds may – or may not – have on the valuation of a closely held company for estate tax purposes. In this case that caused a split between the 8th and 11th Circuits, the 8th Circuit Court of Appeal issued an opinion in June 2023, which will result in additional consideration and scrutiny given to stock purchase agreements funded by life insurance.
The company in question was owned by two brothers, Thomas and Michael. Michael owned $77.18% of the company when he died, and Thomas owned the rest. The brothers had a longstanding stock purchase agreement providing that the company would redeem the shares of the deceased shareholder and would do so by maintenance of a $3.5m life insurance policy on each brother.
At Michael’s death, the company received the $3.5m life insurance, and applied $3m to the purchase of Michael’s shares and $500k to operations. Michael’s estate took the position that the shares were worth $3m, so while the company received the $3.5m, it immediately had an offsetting obligation to pay $3m. The IRS took the position that the fair market value of the company should have included the proceeds, thus the company’s value was $6.86m, meaning Michael’s interest was around $5.3m.
The Court does not get into an analysis of what the result would have been if Thomas died first. In other words, if the company received $3.5m for Thomas’ shares, would the same analysis have been used, and thus Thomas’ estate would only receive $1.6m in exchange, regardless of the amount of the policy? In that case, the company’s value would have been enhanced by the balance of the life insurance proceeds.
What’s to be done? While the brothers had a stock purchase agreement, they did not take the actions required on an annual basis relating to valuation. However, even if they had, the 8th Circuit probably would not have been satisfied, since the actions required would not have resulted in a fixed or determinable price. Companies and small business owners are thus advised, while the split between the Circuits continues, to have a conversation with their advisors. An even more prudent conversation should occur with the business owner’s corporate and estate planning attorneys all in the same room. Please don’t hesitate to contact our Boca Raton, FL office at 561-362-2030 with questions. Our estate planning attorneys collaborate with our corporate and business attorneys to comprehensively address any estate, corporate or tax issues that could arise.