Supreme Court justices acknowledged the difficulty of the question before them at oral argument March 27, drilling counsel for both sides on the effects of stock redemption on corporate valuation and the potential for an estate-tax-free windfall from insurance proceeds.

The key question in Connelly v. United States is whether life insurance proceeds received by a closely held corporation upon the death of a shareholder are corporate assets for estate tax valuation purposes and aren’t offset by the corporation’s obligation to redeem the deceased shareholder’s stock.

The difference in valuation before the Court is stark. The government contends that the total value of Crown C Supply Co. Inc., a closely held Missouri building materials company, was $6.86 million when shareholder Michael Connelly died in 2013. Petitioner Thomas Connelly, Michael’s brother and executor of his estate as well as the surviving shareholder in Crown, valued the company at $3.86 million.

The discrepancy arises because the IRS included $3 million in life insurance proceeds in its valuation of Crown, but the petitioner argues that amount was offset by Crown’s corresponding obligation to redeem Michael’s shares for $3 million.

As the parties presented their arguments, the justices peppered them with questions about the fundamentals of their positions.

Justice Brett M. Kavanaugh asked several questions designed to test — and understand — the complexities inherent in each side’s arguments. On treatment of the redemption obligation, he asked government counsel to “just walk me through that, if you can, because I find this case extremely difficult,” adding that “it seems like a key point and I’d like to hear you explain it again.”

Justice Clarence Thomas wanted to know where $3 million in life insurance proceeds goes if the petitioner’s proposed valuation method is adopted. “The value has to go someplace — the $3 million goes someplace,” Thomas said. “Does it go into the value of the remaining stocks? And if it is there, why isn’t the appropriate valuation $6.86 million?”

Valuing Michael’s Interest

The value of Crown’s stock should be the price a hypothetical willing buyer would pay for it, according to the petitioner’s counsel, Kannon K. Shanmugam of Paul, Weiss, Rifkind, Wharton & Garrison LLP. That buyer would certainly take the redemption obligation into account to offset the insurance proceeds, he argued.

Chief Justice John G. Roberts Jr. agreed that the insurance “money that comes in goes out fairly quickly” to redeem shares.

Government counsel Yaira Dubin of the Justice Department argued that the appropriate measure of Crown’s value instead was the amount divided among Connelly family members. “Crown’s total net worth before the family divided the company was $6.86 million,” because Michael’s heirs got $3 million in cash and “Thomas walked away from the redemption with $3.86 million in value,” Dubin said. The value of those two equity pieces put together is $6.86 million.

Paying $5.13 million for Michael’s 77.18 percent interest in the company — based on the government’s $6.86 million fair market value — would require Crown to sell assets, because the $3.5 million in total life insurance proceeds wouldn’t have been enough to pay that, Shanmugam countered.

Shanmugam pointed out that most of Crown’s assets are... To continue reading please subscribe to NovaTax.