In the Estate of Connelly v. United States,[1] the US District Court for the Eastern District of Missouri determined that a buy-sell agreement did not set the value of the decedent’s interest in a closely held corporation he owned a majority interest in and the proceeds of the life insurance policy held by the company that was used to redeem his shares from his estate had to be included in the calculation of the value of the company for estate tax purposes.

The opinion provides the following broad outline of the facts of this case:

Brothers Michael and Thomas Connelly were the only shareholders in Crown C Supply, Inc., a closely-held family business that sold roofing and siding materials. As is typical in family businesses, the brothers entered into a stock purchase agreement that required the company to buy back the shares of the first brother to die, and the company bought life insurance to ensure it had enough cash to make good on the agreement. When Michael died in October 2013, Crown C repurchased his shares for $3 million, and Michael’s Estate paid estate taxes on his shares in Crown C. But the IRS assessed additional estate taxes of over $1 million. Thomas, as executor of Michael’s Estate, paid the deficiency and filed this suit seeking a refund. At the core of the dispute lies the question of the proper valuation of Crown C on the date of Michael’s death.

Aside from the life-insurance proceeds, Crown C was worth roughly $3.3 million on the date of Michael’s death. On that date, Crown C had an obligation to repurchase Michael’s shares from his Estate. Also on that date, Crown C received (or was about to receive) a cash infusion of $3.5 million from the life-insurance proceeds; without these proceeds, Crown C would have had to deplete its assets or borrow money (or both) to buy Michael’s shares.[2]

The buy-sell arrangement entered into was described as follows:

The Connelly brothers and Crown C signed a Stock Purchase Agreement (the “Stock Agreement”) in 2001, to maintain family ownership and control over the company and to satisfy their estate-planning objectives. Id. at ¶¶ 13-14. The Stock Agreement provided that upon one brother’s death, the surviving brother had the right to buy the decedent’s shares, but the Stock Agreement required Crown C itself to buy (i.e., redeem) the deceased brother’s shares if the surviving brother chose not to buy them. Id. at ¶ 15. When the brothers signed the Stock Agreement, they always intended that Crown C, not the surviving brother, would redeem the deceased brother’s shares. Id. at ¶ 16.

To fund its redemption obligation, Crown C bought $3.5 million in life-insurance policies on both Connelly brothers. Id. at ¶¶ 17-22. Article VII of the Stock Agreement provided two mechanisms for determining the price at which Crown C would redeem the shares. Id. at ¶ 23. Article VII specified that the brothers “shall, by mutual agreement, determine the agreed value per share by executing a new Certificate of Agreed Value” at the end of every tax year. Id. at ¶ 24; Doc. 53-4, Art. VII., Sec. A-B. If the brothers failed to execute a “Certificate of Agreed Value[,]” the brothers would determine the “Appraised Value Per Share” by securing two or more appraisals.2 Doc. 53-4, Art. VII., Sec. A, C. The Connelly brothers never signed a single Certificate of Agreed Value under the Stock Agreement. Doc. 58 at ¶¶ 25-36.[3]

Thus, per the terms of the agreement, since no Certificate of Agreed Value had ever been signed, if Michael’s brother (Thomas) did not exercise the option to buy the shares directly from Michael’s estate (which he did not), there should have been formal appraisals that would have been used to determine the value of the stock for redemption purposes.  But that did not happen—rather Thomas and Michael’s estate came to a separate agreement that governed the sale:

Upon Michael’s death on October 1, 2013, Crown C received about $3.5 million in life-insurance proceeds. Id. at ¶ 39. Thomas chose not to buy Michael’s shares, so Crown C used a portion of the life-insurance proceeds to buy Michael’s shares from Michael’s Estate. Id. at ¶ 16, 39-40. Crown C and the Estate did not obtain appraisals for the value of Michael’s shares under the Stock Agreement, instead entering a Sale and Purchase Agreement (the “Sale Agreement”) for the price of $3 million. Id. at ¶¶ 37-38, 64. Through the Sale Agreement, (1) the Estate received $3 million in cash; (2) Michael P. Connelly, Jr., Michael’s son, secured a three-year option to purchase Crown C from Thomas for $4,166,666; and (3) in the event Thomas sold Crown C within 10 years, Thomas and Michael Jr. agreed to split evenly any gains from the future sale. Id. at ¶¶ 64-66.[4]

Thomas, as executor of his brother’s estate, treated the value of the shares for estate tax purposes as $3 million (the amount paid from the life insurance proceeds to redeem the estate’s interest).  The IRS disagreed with that value, finding that the value of the company taken as a whole had to include the $3 million of life insurance proceeds the estate had the right to immediately upon Michael’s death.  The IRS adjustment in value resulted in an assessment of over $1 million in taxes on Michael’s estate.  The estate paid the tax in question and then filed suit to obtain a refund of the taxes in U.S. District Court.  The parties stipulated that the value of the shares would be $3.1 million if the life insurance proceeds were found by the court to not be considered in determining the value of the company.

Stock Agreement

The first question before the Court was whether the buy-sell agreement controlled the value of the stock for estate tax purposes.  Although under IRC §2703(a) the fair market value of the interest in the company is generally determined without regard to such agreements, IRC §2703(b) allows such an agreement to control the value if three standards are met:

• The arrangement is a bona fide business arrangement,

• The arrangement is not a device to transfer such property to members of the decedent’s family for less than full and adequate consideration in money or money’s worth, and

• The agreement’s terms are comparable to similar arrangements entered into by persons in an arms’ length transaction.[5]

The opinion notes that this issue may not actually be relevant in this case:

The Court begins by observing that the Estate’s arguments all turn on the same premise. The Estate argues that the company sold Michael’s shares at fair market value, Doc. 65 at p. 7, which in turn relies on the assumption that the Estate’s valuation expert correctly valued Michael’s shares. The Estate’s valuation expert, Kevin P. Summers, excluded $3 million in life-insurance proceeds from the valuation, presuming that the Eleventh Circuit’s decision in Estate of Blount controls. Doc. 55-1 at pp. 11-12. And, even though the parties to the Sale Agreement did not value Michael’s shares using the valuation mechanisms set forth in Article VII of the Stock Agreement, the Estate nonetheless argues that the very existence of the Stock Agreement — the parties’ failure to adhere to it notwithstanding — provides sufficient basis for the Court to accept Thomas and the Estate’s ad hoc valuation as the proper estate-tax value of Michael’s shares. Doc. 46 at pp. 8-9.[6]

But the opinion does look at the agreement to see if it fits the statutory requirements in any event.  It is important to remember that the agreement has to meet all three of the requirements to be controlling for the value, so a failure to meet just one of the three requirements is enough to remove the agreement from controlling the value of the interest being redeemed.

Bona Fide Business Arrangement

The IRS first argues the agreement was not a bona fide business arrangement, arguing the brothers did not follow this agreement in good faith, raising both the disregard of the pricing provisions of the agreement and the retention by Michael’s son of an interest in any future sale.

The Court did not find the IRS’s argument on this point persuasive, noting:

“The ultimate question of whether there was a bona fide business arrangement is a question of fact[.]” See Holman v. Comm’r, 601 F.3d 763, 769 (8th Cir. 2010) (citing Estate of True, 390 F.3d at 1218-19). Courts have recognized the validity of agreements to maintain family ownership and control over closely-held businesses. St. Louis Cty. Bank, 674 F.2d at 1210. To establish that the Stock Agreement was a bona fide business arrangement, the Estate needed only to show that the Connelly brothers entered the Stock Agreement for a bona fide business purpose. See id. (“We have no problem with the District Court’s findings that the stock-purchase agreement . . . had a bona fide business purpose — the maintenance of family ownership and control of the business.”); Estate of Lauder v. Comm’r, 1992 WL 386276, *21 (T.C. 1992) (buy-sell agreements had a bona fide business purpose because the “agreements, on their face, serve the legitimate business purpose of preserving family ownership and control of the various Lauder enterprises. We are persuaded that these concerns were a motivating factor in the Lauders’ decision to enter into the agreements.”); Estate of Gloeckner v. Comm’r, 152 F.3d 208, 214 (2d Cir. 1998) (“[W]e agree with the tax court that the Gloeckner agreement represents a bona fide business arrangement. This test is sufficiently satisfied when the purpose of a restrictive agreement is to maintain current managerial control — whether by family or outsiders.”).[7]

In fact, the IRS had agreed to a stipulation that the brothers entered into the agreement to assure continued family control over the business, a reason that the cases cited found to be a valid business purpose for such an agreement. The opinion continues:

The parties here have stipulated that the Connelly brothers entered the Stock Agreement for the purpose of ensuring continued family ownership over Crown C. Doc. 47 at ¶¶ 1-3. The IRS does not provide any support for its contention that the Estate’s actions taken after Michael’s death alter the purpose of the Stock Agreement, making it no longer a bona fide business arrangement. Doc. 61 at p. 12. Based on the parties’ stipulation, the Court deems the Stock Agreement a bona fide business arrangement for purposes of summary judgment.[8]

While the Court did not conclude that the IRS would be unable to show that the brother’s actions served to make the arrangement no longer meet the bona fide business arrangement test, that would require consideration of additional information by the court—thus, summary judgement could not be granted.

But whatever hope the estate might have had based on this finding was extinguished in the following sentence as the Court noted:

Even so, resolution of this issue is ultimately unnecessary because the Stock Agreement fails to meet the other requirements under 26 U.S.C. § 2703(b).[9]

Device to Transfer Property to Family Members at Less Than Full and Adequate Consideration

The bottom line here is whether the buy-sell arrangement was a method to transfer wealth to the decedent’s sibling for less than full and adequate consideration—and here the Court would agree with the IRS that this was the case.

As the reader should note, this provision makes it much tougher for a buy-sell to be respected when the shareholders are related, since the question here is whether it is a design to transfer property to a family member—so had Michael and Thomas been unrelated, this issue would not have arisen.  The burden is on the estate to show that the agreement was not such a device—a burden the estate did not carry.

As we’ll discuss later, the Court found that the life insurance proceeds had to be included as part of the value of the company, disagreeing with the holding of the Eleventh Circuit in the Estate of Blount,[10] instead agreeing with the original Tax Court analysis.[11]  As Missouri is not in the Eleventh Circuit, but rather in the Eighth, the opinion of the Eleventh Circuit does not bind this Court if the opinion is not found to be persuasive on the issue—and the District Court did not find it so.

But even ignoring that issue, the Court found the actions of not following the agreement, but arguing it set the value, made it into solely a device to transfer assets to the decedent’s brother at less than fair value.  The opinion notes:

…[E]ven though Crown C fulfilled the purpose of the agreement by redeeming Michael’s shares, Thomas and the Estate’s process in selecting the redemption price indicates that the Stock Agreement was a testamentary device. See Estate of Gloeckner, 152 F.3d at 216 (“[C]ourts scrutinize the processes employed in reaching the share price contained within the redemption agreement to shed light on the nature of the relationship between the decedent and the person to whom the stock was conveyed.”) (citing Estate of Lauder, 1992 WL 386276, *21-22 and Cameron W. Bommer Revocable Trust v. C.I.R., 1997 WL 473161, at *13 (T.C. 1997)). Thomas and the Estate excluded a significant asset (the life-insurance proceeds) from the valuation of Crown C, failed to obtain an outside appraisal or professional advice on setting the redemption price, Doc. 58 at ¶¶ 23-38; Doc. 51 at p. 4, and as discussed further below, disregarded the appraisal requirement in Article VII of the Stock Agreement, see Section III.A.2.a-b, infra. See also Estate of Lauder, 1992 WL 386276, *21-22 (exclusion of major intangible assets, absence of a formal appraisal, and failure to obtain professional advice may mean the agreement is a testamentary device); St. Louis County Bank, 674 F.2d at 1211 (lack of regular enforcement of the buy-sell agreement’s terms may mean the agreement is a testamentary device); Estate of True, 390 F.3d at 1222 (“[W]here the price term in a buy-sell agreement is reached in an arbitrary manner, is not based on an appraisal of the subject interest, or is done without professional guidance or consultation, courts draw an inference that the buy-sell agreement is a testamentary substitute.”)[12]

The lack of a control premium for Michael’s stock and a minority discount for the value of the stock held by Thomas was also found to indicate that this was a mere device to get the stock to Thomas while bypassing an estate tax on the value of that control premium:

…[T]he Stock Agreement’s lack of a minority discount for Thomas’s shares and corresponding lack of a control premium for Michael’s shares substantially overvalues Thomas’s shares and undervalues Michael’s shares. The Stock Agreement required that in determining the appraised value of the shareholders’ shares in Crown C, “[t]he appraisers shall not take into consideration premiums or minority discounts[.]” Doc. 53-4, Art. VII., Sec. C. The Stock Agreement’s lack of a control premium for Michael’s majority interest indicates that the price was not full-and-adequate consideration. See 26 C.F.R. § 20.2031-2(f)(2) (fair market value for a corporation’s stock is determined by “the company’s net worth, prospective earning power and dividend-paying capacity, and other relevant factors” including “the degree of control of the business represented by the block of stock to be valued . . .”); Bright’s Estate v. U.S., 658 F.2d 999, 1006-7 (5th Cir. 1981) (a willing buyer would account for a controlling interest or a minority interest in a closely-held corporation); Estate of True v. Comm’r, 2001 WL 761280, at *100 (T.C. 2001) (“[Plaintiff’s] 58.16-percent interest represented a majority of the shares entitled to vote; therefore, [Plaintiff] owned a controlling interest in Black Hills Trucking at his death. Accordingly, [the expert] should have added a control premium to compute entity value . . .”); see also Zaiger’s Estate v. Comm’r, 64 T.C. 927, 945-46 (T.C. 1975) (“Petitioner’s experts applied discounts to their valuations to reflect the minority interest involved and to compensate for the fact that voting control would not be in the hands of the purchaser. Such considerations were proper and discounts were appropriate.”).[13]

Advisers are able to use minority discounts in many estate planning situations because that is found to reflect the economic reality—a buyer will pay a premium for a controlling interest in an enterprise and will demand a discount for a minority interest without such control.  These are not concepts the estate or its advisers can simply ignore when not convenient—the IRS has just as much right to assert their actual economic relevance in the minds of a willing buyer.

Thus, the opinion concludes:

While the Connelly brothers’ good health when they executed the Stock Agreement weighs in favor of the Estate’s argument, the parties’ abject disregard of the Stock Agreement so as to undervalue the company and underpay estate taxes, as well as the Stock Agreement’s lack of a control premium or minority discount, demonstrates that the Stock Agreement was a testamentary device to transfer wealth to Michael’s family members for less than full-and-adequate consideration. See Section III.A.2.a-b, infra.[14]

Note that the last two issues do not depend on the Court’s rejection of the Eleventh Circuit view of how the life insurance proceeds should be treated for valuing the company.  Failing to follow the buy-sell agreement’s terms to negotiate a separate deal and having an agreement that fails to take into account valuation concepts such as control premiums would put a buy-sell agreement at risk of being disregarded for estate tax valuation purposes even if the life insurance proceeds are excluded from the valuation as a matter of law.

Comparable to Similar Arms Length Agreements

The court also found that the estate failed to show this agreement was comparable to similar agreements negotiated at arms’ length.

Much of the Court’s conclusions rests on its view that the life insurance proceeds had to be included in the company’s value, thus rendering the amount paid well below the true value.  But the court also again found that the lack of payment of a control premium for Michael’s majority interest also was a key factor in finding this agreement was not like one that would be negotiated between unrelated parties in arms’ length negotiations.

Fixed and Determinable Offering Price

The opinion notes that, in addition to the statutory requirements just discussed, case law and the regulations require an agreement to provide a fixed and determinable price in order to be respected.  In practice, the IRS argued that this agreement simply didn’t provide such a readily determinable price:

The IRS contends that the price of Michael’s Crown C shares was not fixed and determinable under the Stock Agreement because Thomas and the Estate ignored the agreement’s pricing mechanisms and came up with a valuation of their own. Doc. 52 at p. 7; Doc. 61 at p. 5. The Stock Agreement required shareholders Michael and Thomas to agree on and sign “Certificates of Agreed Value” every year to establish the price-per-share; but in the 12 years the agreement was in place before Michael’s death, they never agreed on the value, or created or signed such certificates. Doc. 61 at p. 5; Doc. 53-4, Art. VII., Sec. A-B. Under the Stock Agreement, the failure of the shareholders to do so triggered the obligation to obtain the Appraised Value Per Share through a very specific process involving multiple professional appraisers. Doc. 53-4, Art. VII., Sec. C. But Thomas and the Estate never followed that specific process and never determined the Appraised Value Per Share; instead, they chose to come up with their own ad hoc valuation of $3 million. Doc. 58 at ¶¶ 23-38; Doc. 51 at p. 4.[15]

The opinion agreed with the IRS that these issues meant that the agreement did not provide for a fixed and determinable share price arising from the buy-sell agreement.

The estate attempts to rescue this issue by arguing that the mere existence of such an agreement, even if ignored, satisfied this requirement.  That is, had the brothers set a value each year or had appraisers been used to arrive at the value (rather than just an agreement between the estate and the minority shareholder/executor), the agreement would have met this requirement.  But the Court noted that, regardless, the value the estate placed on the shares was not obtained from this agreement:

But the Estate does not ask the Court to apply one of the price-setting mechanisms set out in the Stock Agreement; it wants the $3 million price to control estate-tax valuation, even though that price has no mooring in the Stock Agreement. Id. Further, the Estate’s citation to Estate of Gloeckner is unpersuasive, as in Estate of Gloeckner, the Commissioner conceded that the buy-sell agreement at issue had a “fixed and determinable” offering price. 152 F.3d at 213 (“The Commissioner does not dispute that the restrictive agreement affecting Gloeckner’s shares meets the first three requirements. That is, it concedes the stock price at issue was fixed within the redemption agreement . . .”).[16]

The opinion concludes that the agreement’s mechanism was ignored because the parties believed it would result in a far higher value than served the parties’ interests:

The Estate argues that the $3 million price “resulted from extensive analysis of Crown C’s books and the proper valuation of assets and liabilities of the company. Thomas Connelly, as an experienced businessman extremely acquainted with Crown C’s finances, was able to ensure an accurate appraisal of the shares.” Doc. 51 at p. 4. Leaving aside Thomas’s obvious self-interest in arriving at a below-market valuation, this argument reveals the frailty of the Estate’s position: the Estate didn’t believe that the very specific valuation mechanism in the Stock Agreement produced an accurate value that bound the Estate, but the Court should treat it as if it did. The Court finds this position as untenable as it is unpersuasive.[17]

Binding During Life and After Death

As well, the case law and regulations require that such an agreement, to set the value of the interest, must be binding both during life and after death.

The court did not agree with the IRS view that the agreement was not binding during life because the parties had failed to set a value annually:

As discussed in section III.A.2.a, above, the Stock Agreement required shareholders Michael and Thomas to agree on and sign “Certificates of Agreed Value” every year to establish the price-per-share, but they never agreed on the value, or created or signed such certificates. Doc. 61 at p. 5; Doc. 53-4, Art. VII., Sec. A-B. During life, the parties did not treat that aspect of the Stock Agreement as binding, but the Stock Agreement (for reasons unknown) anticipated that they might not comply with Certificates-of-Agreed-Value provision; accordingly, and insofar as the binding-during-life-and-death analysis goes, the Court does not find the parties’ failure in this regard entirely dispositive. See Doc. 53-4, Art. VII., Sec. C.[18]

The existence of a “fall back” provision should the parties fail to set a value did provide a mechanism for the agreement to continue to operate even in that condition.  But what happened at Michael’s death proved that the parties did not view the agreement as binding at death:

The parties’ own conduct demonstrates that the Stock Agreement was not binding after Michael’s death. Thomas and the Estate failed to determine the price-per-share through the formula in the Stock Agreement. See St. Louis County Bank, 674 F.2d at 1210-11 (parties’ post-execution conduct can determine whether the court applies the terms of a buy-sell agreement for estate-tax purposes); Estate of Lauder, 1992 WL 386276, *19 (allowing some minor deviations from the buy-sell agreement’s terms, but finding that the family still considered the agreement’s terms to be binding because the family executed formal waivers and modifications as the buy-sell agreement required). As already discussed in section III.A.2.a, Thomas and the Estate did not consider the Stock Agreement to be binding or enforceable on them; they ignored the price mechanism in Article VII and sold Michael’s shares for $3 million without first obtaining any appraisals for Crown C.[19]

Fair Market Value

Having now determined that the buy-sell agreement does not qualify to set the value of the decedent’s interest, the court turns to whether the life insurance proceeds should be considered when determining the value of the company.

The estate argues that the $3 million in life insurance proceeds triggered by Michael’s death should be ignored because it is offset dollar for dollar by an obligation that existed to redeem Michael’s interest in the corporation.  The Eleventh Circuit in Blount had arrived at exactly that view:

The Tax Court in Estate of Blount included the life-insurance proceeds in the value of the company and the shareholders’ shares, determining that the redemption obligation was not like an ordinary liability because the redemption involved the very same shares being valued. 2004 WL 1059517, at *26. The Eleventh Circuit reversed on this issue, holding that the fair market value of the closely-held corporation did not include life-insurance proceeds used to redeem the shares of the deceased shareholder under a stock purchase agreement. Estate of Blount, 428 F.3d at 1346. The Eleventh Circuit reasoned that the stock-purchase agreement created a contractual liability for the company, offsetting the life-insurance proceeds. Id. at 1345-46. The Eleventh Circuit concluded that the insurance proceeds were “not the kind of ordinary nonoperating asset that should be included in the value of [the company] under the treasury regulations” because they were “offset dollar-for-dollar by [the company’s] obligation to satisfy its contract with the decedent’s estate.” Id. at 1346 (citing 26 C.F.R. § 20.2031-2(f)(2)).[20]

However, this court does not accept the Eleventh Circuit’s view—and, as was noted earlier, since this case would not have its appeal heard by the Eleventh Circuit the District Court was free to disagree with that view since the Eighth Circuit had not spoken to this issue.

The key issue is whether the redemption obligation was a corporate liability that would serve to reduce the value of the corporation.  The opinion agrees with the Tax Court’s view in this area that since the insurance proceeds would go directly to the holder of the shares being valued, it should not be excluded in valuing those shares prior to that asset being transferred to the holder of those shares:

Under the willing-buyer-willing-seller principle, a redemption obligation does not reduce the value of a company as a whole or the value of the shares being redeemed. A redemption obligation requires a company to buy its own shares from a shareholder, and just like any other contractual obligation, a redemption obligation expends company resources. But as the Tax Court observed in Estate of Blount, a redemption obligation is not a “value-depressing corporate liability when the very shares that are the subject of the redemption obligation are being valued.” 2004 WL 1059517, at *25.

Consider what a hypothetical “willing buyer” would pay for a company subject to a redemption obligation. See 26 C.F.R. § 20.2031-1(b). The willing buyer would not factor the company’s redemption obligation into the value of the company, because with the purchase of the entire company, the buyer would thereby acquire all of the shares that would be redeemed under the redemption obligation; in other words the buyer would pay all of the shareholders the fair market value for all of their shares. The company, under the buyer’s new ownership, would then be obligated to redeem shares that the buyer now holds. Since the buyer would receive the payment from the stock redemption, the buyer would not consider the obligation to himself as a liability that lowers the value of the company to him. See Estate of Blount, 2004 WL 1059517, at *25 (T.C. 2004) (“To treat the corporation’s obligation to redeem the very shares that are being valued as a liability that reduces the value of the corporate entity thus distorts the nature of the ownership interest represented by those shares.”).

A willing buyer purchasing Crown C on the date of Michael’s death would not demand a reduced purchase price because of the redemption obligation in the Stock Agreement, as Crown C’s fair market value would remain the same regardless. The willing buyer would buy all 500 of Crown C’s outstanding shares (from Michael’s Estate and Thomas) for $6.86 million, acquiring Crown C’s $3.86 million in estimated value plus the $3 million in life-insurance proceeds at issue. If Crown C had no redemption obligation, the willing buyer would then own 100% of a company worth $6.86 million.

But even with a redemption obligation, Crown C’s fair market value remains the same. Once the buyer owned Crown C outright, the buyer could either: 1) cancel the redemption obligation to himself and own 100% of a company worth $6.86 million, or 2) let Crown C redeem Michael’s former shares — the buyer (and not Michael’s Estate) would receive roughly $5.3 million in cash and then own 100% of a company worth the remaining value of about $1.56 million, leaving the buyer with a total of $6.86 million in assets. Therefore, with or without the redemption obligation, the fair market value of Crown C on the date of Michael’s death was $6.86 million.[21]

Or, to put it more simply, the buyer of all interests in the company ends up with either:

• A company worth $6.86 million (assuming the proceeds are retained by the company) or

• $3 million in cash and a company now worth $3.86 million following the redemption of the portion of the shares acquired that represented the decedent’s interest.

The opinion then argues that what is really happening is a transfer of the full value of the company prior to the insurance proceeds to Thomas at no cost to him—a transfer for less than full and adequate consideration:

Demonstrating this point, exclusion of the insurance proceeds from the fair market value of Crown C and valuing Michael’s shares at $3 million results in drastically different share prices for Michael’s shares compared to Thomas’s. If on the date of his death, Michael’s 77.18% interest was worth only $3 million ($7,774/share), that would make Thomas’s 22.82% interest worth $3.86 million ($33,863/share) because Thomas owned all other outstanding shares and the residual value of Crown C was $3.86 million. See Doc. 53-19 at ¶ 61. The residual value of Crown C is the value of the company apart from the $3 million of insurance proceeds at issue. The parties have agreed that this value was $3.8 million. Doc. 48 at ¶¶ 1-3; Doc. 58 at ¶¶ 43, 79-81. Because Thomas was the only other shareholder of Crown C, his ownership interest must therefore equal the residual value of Crown C: $3.8 million. This outcome violates customary valuation principles because Thomas’s shares would be worth 336% more than Michael’s at the exact same time. See Doc. 53-19 at ¶ 61. A willing seller of Michael’s shares would not accept this bargain, as it creates a windfall for the buyer (Crown C of which Thomas would now have 100% control), while undervaluing Michael’s shares in comparison.

Only by including the insurance proceeds in the fair market value of Crown C do Michael’s and Thomas’s shares hold an equal value on the date of Michael’s death. Michael’s 77.18% interest in a $6.86 million company would be worth $5.3 million ($13,782/share) and Thomas’s 22.82% interest would be worth $1.56 million ($13,782/share). This outcome tracks customary valuation principles, because the brothers’ shares have the same value-per-share. A willing seller of Michael’s shares would only accept this outcome, because it assigns the same value to Michael’s shares as to Thomas’s and neither party’s economic position changes through the transaction.[22]

Ultimately the opinion concludes:

For these reasons, the Court respectfully finds that the Eleventh Circuit’s opinion in Estate of Blount is “demonstrably erroneous” and there are “cogent reasons for rejecting [it].” Keasler v. United States, 766 F.2d 1227, 1233 (8th Cir. 1985) (“[T]he tax decisions of other circuits should be followed unless they are demonstrably erroneous or there appear cogent reasons for rejecting them.” (internal quotation marks and citation omitted)). Accordingly, the Court holds that the $3 million in life-insurance proceeds used to redeem Michael’s shares must be included in the fair market value of Crown C and of Michael’s shares.[23]

[1] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021, https://www.taxnotes.com/research/federal/court-documents/court-opinions-and-orders/life-insurance-proceeds-included-in-company%e2%80%99s-estate-tax-valuation/78c7k (retrieved September 23, 2021)

[2] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[3] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[4] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[5] IRC §2703(b)

[6] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[7] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[8] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[9] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[10] Estate of Blount v. Commissioner, 428 F.3d 1388 (11th Circuit 2005)

[11] Estate of Blount v. Commissioner, TC Memo 2004-116, May 12, 2004

[12] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[13] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[14] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[15] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[16] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[17] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[18] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[19] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[20] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[21] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[22] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021

[23] Estate of Connelly v. United States, USDC ED MO, Case No. 4:19-c-01410, September 21, 2021