Serving Columbia, Waterloo, Monroe County, St. Clair County, and surrounding counties in Illinois; and St. Louis, St. Louis County, Jefferson County, and surrounding counties in Missouri.

If your company owns life insurance to redeem a deceased owner’s shares, the insurance proceeds can increase the company’s value for estate tax purposes—this is the core problem highlighted by Connelly v. United States (U.S. Sup. Ct. 2024). Three cleaner ways to fund a buy‑sell without inflating the operating company’s value are (1) a cross‑purchase agreement; (2) a irrevocable life insurance trust (ILIT); or (3) a separate insurance‑holding LLC or trust that owns the policies and pushes cash to survivors for the buy‑sell. Life insurance death benefits are generally excluded from income under IRC §101(a) (watch the transfer‑for‑value rules).

What Connelly Means for Small Business Owners

When a corporation owns the policy and receives the death benefit, the corporation’s assets increase and the redemption obligation does not reduce value. The decedent’s stock is therefore worth more, which can raise estate taxes. The simple fix is to keep life insurance off the operating company’s balance sheet.

Three Structures that Avoid the Connelly Trap

1) Cross‑Purchase Agreement

• How it works: Each owner buys/owns a policy on the others. At death, survivors buy the decedent’s shares directly from the estate.
• Advantages: Proceeds never hit the company’s balance sheet; buyers get basis step‑up; clean owner‑to‑owner economics.
• Considerations: Admin grows with more owners; premiums paid personally or via side agreements.
• Best for: Two to four owners who want a clean, direct buy‑sell.

2) ILIT (Irrevocable Life Insurance Trust)

• How it works: A trustee owns the policy for the insured owner’s family. Proceeds are outside the insured’s estate and generally income‑tax‑free under §101(a). The trustee can lend or distribute cash to help the estate or facilitate the buy‑sell.
• Crummey notices: The trustee gives beneficiaries temporary withdrawal rights over each contribution used to pay premiums so annual gifts qualify for the §2503(b) exclusion. Keep signed notices/receipts.
• Best for: Owner‑centric plans prioritizing estate‑tax exclusion and creditor protection.

3) Insurance‑Holding LLC (or Trust)

• How it works: A separate LLC owns one policy per owner and pays premiums. At death, the LLC distributes or loans proceeds to survivors to fund a cross‑purchase under a separate buy‑sell—keeping proceeds off the operating company’s books.
• Drafting for valuation safety: Build the §2703 safe harbors (bona fide purpose, not a device, arm’s‑length comparability), implement FMV appraisal mechanisms, and align dissolution terms with state law consistent with Reg. §25.2703‑1 and Reg. §25.2704‑2.
• Best for: Two to five co‑owners who want centralized premiums/policies and scalable administration.

Which Structure Fits Your Business?

Next Steps for Illinois Owners

1. Get a current appraisal (or valuation update) for your business.
2. Choose the funding structure that matches your goals.
3. Coordinate the documents: buy‑sell + ILIT or insurance‑holding LLC.
4. Document business purposes and keep your records (policies, notices, appraisals) organized.

Schedule a Conversation

We help closely held businesses across Columbia, Waterloo, Monroe County, St. Clair County, and surrounding counties in Illinois; and St. Louis, St. Louis County, Jefferson County, and surrounding counties in Missouri design and implement the right approach. Book a consultation or contact us.

Helpful Resources

• Estate Planning
• Trust Administration
• Business Formation
• Why Put Your Home in a Living Trust
• What to Know Before You Buy a Business

Authoritative Sources

• • Connelly v. United States (Supreme Court opinion, PDF)
  • 26 U.S.C. §101 (Life insurance proceeds)
  • 26 U.S.C. §2703 (Certain rights and restrictions disregarded)
  • 26 U.S.C. §2704 (Restrictions on liquidation)
  • 26 C.F.R. §25.2703‑1 (Regulations)
  • 26 C.F.R. §25.2704‑2 (Regulations)

Legal disclaimer: This article is for informational purposes only and does not constitute legal or tax advice. Consult your advisors.