Many businesses have used corporate owned life insurance (COLI) and buy-sell agreements as key elements of their succession planning. However, it may be time to consider whether these programs are creating unnecessary risk. Although these programs generally have not been problematic in the past, a recent Supreme Court case has potentially changed the analysis.
COLI is a life insurance policy owned by the company on the life of an employee, with some or all the benefits payable to the company. This life insurance can provide a significant cash benefit at a time when the company may be looking to fund the repurchase of shares from a deceased owner. Historically, practitioners have excluded insurance proceeds from a business’s valuation when those proceeds are contractually designated for repurchasing shares under a buy-sell agreement. This exclusion arises because the buy-sell agreement creates a liability that offsets some or all of the proceeds. Although excluding the value of the insurance proceeds from the value of the business was relatively common, the IRS had sometimes argued that the value of the insurance should be included in the value of the company.
In Connelly v. U.S., the Supreme Court unanimously held that the proceeds from COLI need to be included in some valuations of the company that received the proceeds. When the value of the COLI is added for tax and valuation purposes, there are several possible implications. First, the increased value from including the COLI may have to be reflected in a higher purchase obligation under the buy/sell obligation associated with the COLI than would otherwise be necessary. Second, the value of the COLI may need to be included in company valuations related to deferred and executive compensation payments. Third, the inclusion of COLI proceeds as an asset on the company’s balance sheet may impact the company’s investment or lending agreements. And fourth, the increased value of the company needs to be reflected when valuing the decedent’s company equity for estate tax purposes and in any tax planning for surviving owners.
After Connelly v. U.S., companies and business owners should reassess how COLI and buy-sell agreements interact. If a COLI and a buy-sell agreement are already in place, now is a good time to review them to determine if changes need to be made. If so, make those changes before it’s too late. For companies that do not have COLI and a buy-sell agreement in place, it is a good time to determine if your business should have these arrangements in place now that the Supreme Court has settled the question.
If you have questions about COLI, buy-sell agreements, and their implications for your business, contact a member of Varnum’s Employee Benefits, Corporate, or Estate Planning Practice Teams.
