The One Big Beautiful Bill Act made the federal estate-tax exemption permanent at $15 million per person for 2026, and most owners of closely held businesses read that as the end of the Connelly problem. It is not. The Supreme Court’s unanimous 2024 ruling in Connelly v. United States held that the life insurance a company buys to fund a buy-sell redemption of a dead owner’s shares inflates the company’s value for estate-tax purposes, and that the obligation to redeem does not offset the proceeds. With the federal exemption now beyond the reach of most family businesses, the place that ruling still bites is the state estate tax, where exemptions sit as low as $1 million and a single insurance-funded redemption can manufacture a six-figure bill the owner never saw coming.
That migration, from a federal problem to a state one, is the planning story advisors are missing. The reflex after OBBBA was to file Connelly under “solved by the $15 million exemption.” For a business owner in Massachusetts, Oregon, or Washington, it is the opposite of solved. The same insurance that funds the buyout now pads the taxable estate against a threshold a fraction the size of the federal one, and the structure that caused it can usually be undone with a redraft.
Key Takeaways
- In Connelly v. United States (June 6, 2024), the Supreme Court ruled unanimously that company-owned life insurance funding a share redemption is added to the company’s estate-tax value and is not offset by the redemption obligation.
- OBBBA’s permanent $15 million federal exemption ($30 million per couple) removes the federal sting for most family businesses but changes nothing at the state level.
- Roughly 17 states plus the District of Columbia levy an estate or inheritance tax. Massachusetts exempts only $2 million, Oregon $1 million, and Washington $3 million with the nation’s highest top rate at 35%.
- A worked example shows an insurance-funded redemption swinging $82,400 of Massachusetts estate tax on an owner who owes nothing at the federal level.
- The fixes are structural: cross-purchase agreements and properly operated insurance LLCs keep the proceeds out of the company’s value, while company-owned redemption policies are the exposure.
What Did Connelly Actually Decide?
The facts were ordinary, which is why the ruling reaches so many businesses. Two brothers, Michael and Thomas Connelly, owned Crown C Supply. A buy-sell agreement called for the surviving brother or the company to buy a deceased brother’s shares, and the company held life insurance to fund it. Michael died, the company collected about $3.5 million, and it used $3 million to redeem his stock.
The estate argued the company’s value should exclude the insurance proceeds, because the money was earmarked to buy out the shares and left the business almost as soon as it arrived. The IRS disagreed, and the Supreme Court sided with the IRS. The Court held that a corporation’s obligation to redeem shares does not offset the value of the life insurance it receives, so the proceeds count in the company’s fair market value for estate-tax purposes. The decedent’s stock is valued as if the company were worth its operating value plus the full insurance payout.
The Stinson LLP analysis of the decision put the mechanism plainly: company-owned insurance funding a redemption inflates the gross estate, even though the proceeds are spent the same day on the buyout. The brothers had built a plan they thought was funded and neutral. The Court read it as a plan that made the company suddenly worth millions more at the exact moment it mattered.
Why Didn’t the $15 Million Exemption Make This Go Away?
At the federal level, for many owners, it did. A company worth $4 million in operating value plus a $2 million policy produces a $6 million valuation, and a 50% owner’s $3 million stake sits comfortably under the $15 million federal exemption. No federal estate tax is due, so the Connelly inflation costs that owner nothing in Washington’s terms.
State estate taxes are a different machine. As our analysis of the $15 million estate exemption and OBBBA planning noted, the federal number is now permanent and high, but it has no bearing on the separate taxes that about 17 states and the District of Columbia impose. Those exemptions never tracked the federal figure and were not touched by OBBBA. Massachusetts holds its exemption at $2 million and does not index it. Oregon sits at $1 million. Washington raised its threshold to roughly $3 million in 2025 but pushed its top marginal rate to 35%, the steepest in the country.
So the owner who owes zero federal estate tax can still owe a state one, and the Connelly proceeds are what carry the estate over the state line. A $2 million stake that would have sat at the Massachusetts exemption becomes a $3 million stake once the insurance is added, and the tax attaches to the difference. The federal headline created a false sense of safety for exactly the family-business owners in high-tax states who are most exposed.
How Big Is the State Estate-Tax Hit? A Worked Example
Put real numbers on it. Two siblings own a Massachusetts manufacturing company 50/50. The operating value is $4 million, and the company owns a $2 million policy on each sibling to fund a buy-sell redemption. One sibling dies.
Under the redemption structure, Connelly values the company at $4 million of operating value plus the $2 million insurance payout, or $6 million. The decedent’s 50% interest is worth $3 million. Federally, $3 million is far under the $15 million exemption, so the federal estate tax is zero. Massachusetts is where the bill lands. On a $3 million estate, the adjusted taxable estate is $2,940,000 after the state’s $60,000 adjustment, the preliminary tax from the Department of Revenue rate table is $182,000, and after the $99,600 credit the estate owes $82,400.
Now run the same family through a cross-purchase or an insurance LLC that funds a cross-purchase, so the proceeds never enter the company. The company is valued at its $4 million operating value alone. The decedent’s 50% interest is $2 million, which sits at the Massachusetts exemption, where the $99,600 credit shelters it, and the state tax falls to zero. Same insurance, same family, same buyout. The only variable is whether the company or the surviving sibling receives the proceeds, and that choice is worth $82,400 in Massachusetts tax on an estate that owes nothing to the federal government.
Which Buy-Sell Structures Survive Connelly?
The exposure comes from one specific design: the operating company owns the policy and redeems the shares. Move the insurance out of the company and the inflation disappears. Two structures do that.
The cleanest is a cross-purchase agreement. The surviving owners personally own policies on each other, collect the proceeds directly, and use them to buy the deceased owner’s shares. The company never owns the insurance and never receives the payout, so nothing inflates its value. The drawback is arithmetic. With four owners, a full cross-purchase needs twelve policies, because each owner insures the other three, and age or health gaps make the premiums uneven. The structure is elegant for two or three owners and unwieldy beyond that.
The scalable answer is an insurance LLC, sometimes called a policy LLC or special-purpose vehicle. A separate LLC owns one policy per owner in the same percentages as the operating company, collects the proceeds, and distributes them to fund a cross-purchase. The Bowditch & Dewey analysis from late 2025 and the Harris Beach Murtha guidance both stress the same point: the LLC works when it has a genuine business purpose such as administrative efficiency or premium equalization, keeps separate books and governance, and funds a cross-purchase rather than a redemption. The drafting should prohibit the operating company from being the policy beneficiary and require the surviving owners, not the company, to buy.
When Does an Insurance LLC Get Disregarded?
The structure is not a magic wrapper, and a sloppy one fails. The IRS can disregard an insurance LLC that is a shell, an entity with ownership identical to the operating company, no separate activity, and no purpose beyond funneling proceeds into a redemption. Collapse the LLC and the proceeds are treated as the company’s again, which recreates the Connelly inclusion the owner paid a lawyer to avoid.
The line is genuine substance. An insurance LLC that maintains its own bank account, keeps minutes and records, documents a business reason for existing, and actually directs proceeds to surviving owners is respected. One that exists only on paper to relabel a redemption is not. This is the same discipline that runs through the trust restructuring playbook for $3 million to $14 million estates: the document has to do what it says, with separate administration and a real purpose, or a court reads through it to the economic reality.
The timing question is the one that catches owners by surprise. A buy-sell agreement signed in 2015 and funded with company-owned insurance is a live Connelly exposure today, and the owners may have no idea the 2024 ruling changed the math under them. The fix is a redraft and, often, a reassignment of existing policies into a cross-purchase or insurance LLC, work that has to happen while every owner is alive and insurable. After a death, the structure is locked and the inclusion is fixed.
Three Questions Every Business-Owner Client Should Answer
Connelly rewards advisors who read the buy-sell agreement instead of assuming the $15 million exemption covered it. Three questions belong in every review of a closely held business this year.
1. Does the operating company own the life insurance that funds the buy-sell? If the answer is yes and the agreement calls for a redemption, the client has a live Connelly exposure. Pull the policy ownership and the agreement together and confirm who is named as owner and beneficiary, because that one fact decides whether the proceeds inflate the estate.
2. Does the client live or own property in a state with its own estate tax? Run the company valuation against the state threshold, not the federal one. A client in Massachusetts, Oregon, Washington, or another estate-tax state can owe a six-figure state bill while owing nothing federally, and the Connelly proceeds are usually what cross the line.
3. Is the agreement still drafted the way it was before June 2024? A buy-sell signed before the ruling almost certainly assumes the old offset that the Court rejected. Schedule the redraft, the policy reassignment, and the cross-purchase or insurance-LLC conversion while every owner is healthy and insurable, because the window to fix it closes at the first death.
About Me
Aimad Zahid is Master's degree, Management science - Finance and investment strategist with experience in asset management, corporate strategy, and multi-asset investing
