Business Succession After Connelly: Life Insurance and Buy-Sell Agreements

• August 24, 2025
• by A.H.Steinmetz, Ltd.
• A.H.Steinmetz Ltd

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 a corporation owns life insurance to redeem a deceased owner’s shares, the proceeds can increase the company’s estate-tax value. In Connelly v. United States, the Supreme Court held that the obligation to redeem shares at fair market value did not offset the proceeds in that valuation. Cross-purchase agreements, ILITs, and separate insurance-owning entities are alternatives to evaluate; none is an automatic estate-tax solution.

What Connelly Means for Small Business Owners

Connelly concerns the value of the business interest included in the decedent’s estate. Personal policy ownership presents a separate inclusion question. Review both the buy-sell arrangement and life insurance estate-tax rules before moving a policy or assuming an exclusion.

Three Structures to Evaluate After Connelly

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 under the trust’s terms. Exclusion from the insured’s estate depends on retained rights, ownership history, and applicable rules, including Section 2035’s three-year rule. Any loan or purchase supporting the estate must be properly authorized and structured; required use of proceeds for estate obligations can affect inclusion.
• Premium gifts: Genuine withdrawal rights may help a contribution qualify as a present-interest gift. Notices alone do not establish qualification. Review the trust terms, beneficiaries’ actual rights, and gift-tax reporting rules.
• 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?

Compare who must buy the shares, who will own and receive the insurance, how premiums are funded, and how the purchase price is determined. A separate entity may address the operating company’s receipt of proceeds while creating other ownership or valuation questions.

An ILIT requires an estate-inclusion review. A cross-purchase requires an assessment of each buyer’s funding and policy ownership. An insurance-holding entity needs governing documents and a tax review of its interests and transfers.

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.

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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.

For the broader ownership and management questions, read what happens to your LLC when you die.