Why Most Buy-Sell Agreements Don't Survive a Death Claim

What Connelly v. United States Means for Washington Business Owners

The buy-sell agreement your company signed years ago may already be obsolete.

Not because it was poorly drafted. Because the ground it was built on shifted in 2024, and most business owners have no idea it happened.

A few questions worth sitting with — depending on where you stand today.

If you already have an agreement in place: When was the last time your CPA or estate attorney actually reviewed it — not filed it away, but reviewed it? A shift in the legal landscape in 2024 quietly aged out agreements that were airtight the day they were signed. An unreviewed agreement doesn't fail today. It fails the day someone tries to use it — during probate, during a dispute, at the exact moment your family or partners can least afford a surprise.

Does the valuation formula assume the life insurance payout will offset the buyout obligation, dollar for dollar? That assumption used to be safe. It isn't anymore. When it breaks, the payout meant to make the transition clean can instead inflate what the estate owes — a tax bill nobody budgeted for, landing on people who just lost a partner.

Is it structured as an entity redemption, where the company itself owns the policy and buys back the shares? Here's the mechanism that can quietly turn a routine agreement into an unbudgeted tax bill: this is the most common structure in the country — and the one most exposed to what changed. The more insurance the company holds to fund the buyout, the larger the deceased owner's taxable estate can become. That's the opposite of what the agreement was built to do.

If you don't have an agreement at all: this isn't a smaller problem. It's a bigger one. Without a buy-sell agreement, there's no contract forcing a clean transition when an owner dies, becomes disabled, or wants out. Their shares can pass directly to a spouse or heir with no interest in running the business, no obligation to sell, and every legal right to a seat at the table. Surviving owners can end up in business with someone they never chose — no agreed valuation, no funding source, no timeline. Deadlock, forced dissolution, and drawn-out family disputes usually start exactly here.

The Ruling That Changed the Math: Connelly v. United States

Michael and Thomas Connelly spent decades running a family building supply company in St. Louis. Like a lot of owners, they'd done the responsible thing: a stock purchase agreement, signed years earlier, so the business would stay in the family and pass cleanly if one of them died. If the surviving brother didn't want to buy the shares himself, the company would redeem them — funded by $3.5 million in life insurance the company carried on each brother.

Michael died in 2013. Thomas declined to buy the shares personally, so the company redeemed them instead, using the insurance proceeds exactly as the agreement intended. The estate reported the company's value at roughly $3.86 million and paid tax on that basis.

The IRS disagreed. Its argument: the $3 million in life insurance the company used to fund the redemption was still a company asset the moment before it was spent, and should be counted toward the company's value for estate tax purposes — regardless of the fact that the company was contractually obligated to spend it. That pushed the company's value to $6.86 million, and Michael's 77% stake from roughly $3 million to $5.3 million.

The case reached the Supreme Court. On June 6, 2024, the Court ruled unanimously, 9-0, for the IRS in Connelly v. United States. The redemption obligation does not offset the value the insurance adds. The agreement worked exactly as written — and still produced close to $890,000 in additional estate tax that nobody had planned for.

Here's the wrong conclusion to draw from this: "then we just won't fund the buyout with life insurance." That's not the answer. Insurance is still how most owners fund a clean buyout without draining cash reserves or forcing a fire sale to raise it. The problem isn't the insurance — it's the structure sitting underneath it. Some structures carry this exposure. Others were built specifically to avoid it, and can still get an owner to the same outcome the Connellys wanted in the first place.

This isn't a one-company problem, either way. The ruling applies to any entity redemption agreement funded by company-owned life insurance — any industry, any size, anywhere in the country.

Why This Hits Differently in Washington

Starting January 1, 2026, the federal estate tax exemption jumped to $15 million per person — $30 million for a married couple. For a lot of business owners, that number felt like the all-clear. A company worth $5M, $6M, even $8M is nowhere close to $15M. Estate planning quietly moved off the to-do list.

Washington didn't move with it. The state's estate tax exemption sits at $3 million per person — not portable between spouses, and locked in place since a rate rollback took effect July 1, 2026. One exemption is twelve million dollars higher than the other, and both are live on the same estate at the same time.

Here's where the mechanism above becomes personal instead of theoretical. Say a Washington business, co-owned 50/50 by two partners, is worth $4 million on its own — comfortably under both thresholds, nothing to worry about, on paper. Now add the $2–3 million in company-owned life insurance funding the buy-sell agreement. Under Connelly, that insurance counts toward the company's value. $4 million can become $6–7 million. Each owner's taxable share can cross $3 million fast — landing squarely inside Washington's 10%–20% estate tax bracket, on a business that felt nowhere near an estate tax problem at all.

Married, with no trust planning addressing this? The exposure compounds. Federal estate tax runs on "use it or pass it on" — a surviving spouse can inherit whatever exemption the first spouse didn't use. Washington runs on "use it or lose it" — there's no portability, so a surviving spouse can't pick up whatever the first spouse left unused. Unless that was addressed in advance, it's simply gone at the first death.

None of this makes insurance-funded buy-sell agreements the wrong tool. It means the structure holding the insurance matters as much as the coverage itself.

What Actually Holds Up: Structuring Options That Avoid the Trap

A few myths worth clearing up.

Myth: "We have to unwind and rebuild our whole agreement immediately." Reality: moving a policy from corporate ownership to individual or trustee ownership without coordinated tax counsel can trip transfer-for-value rules — creating a taxable event on the way out of one problem and straight into another. An existing entity-redemption agreement isn't an emergency. It's a planning conversation, done properly, on its own timeline.

Myth: "Cross-purchase agreements require too many policies to be practical." Reality: true for a straight cross-purchase with a lot of owners — the policy count grows fast, since each owner needs a policy on every other owner. But that's not the only path to cross-purchase tax treatment. A trusteed cross-purchase structure, or an insurance-only LLC, lets an independent trustee (or the LLC) hold one policy per owner instead of one per pair — same Connelly-avoidance benefit, without the policy count problem.

Myth: "As long as the insurance is in place, the structure doesn't really matter." Reality: this is the core misunderstanding running through all of this. It was never about whether insurance exists. It's about who owns it. Insurance owned by the company inflates the company's value under Connelly. Insurance cross-owned directly by the co-owners, or held by an independent trustee, generally doesn't.

The Bottom Line

None of this is a solo decision. Redrawing a buy-sell structure touches corporate law, tax law, and the insurance funding it — a three-way conversation between a producer, a CPA, and an estate attorney, not a single-advisor call. The value in catching this early isn't fixing it alone. It's being the one who noticed before anyone had to find out the hard way.

The fix was never complicated. It's just rarely done before it's needed.

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