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Trust Law/Level VII · Property and business/7.2 Business/Lesson 6

Business succession planning

What happens to a closely held business when an owner dies or loses capacity, how buy-sell agreements and trusts are used, and what Connelly v. United States (2024) decided about insurance-funded redemptions.

Education, not legal advice. Trust law changes from country to country and state to state, and the right structure depends on your situation. Anything you sign should be drafted or reviewed by a qualified lawyer where you live.

The lean path

The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.

  1. Cheapest first step: a signed buy-sell agreement and a durable power of attorney, so a buyer, a price and a stand-in exist in advance; under IRC §2703 the price counts for estate tax only on arm’s-length, non-family-device terms.
  2. After Connelly v. United States (2024), company-owned life insurance used for a redemption raises the company’s value for estate tax; a cross-purchase funded by the owners’ own policies avoids that, at the cost of more policies.
  3. Give non-voting shares or LLC units gradually, up to $19,000 per recipient in 2026 without using exemption; voting and non-voting common keeps an S corporation at one class of stock. Larger gifts need Form 709.
  4. Below the $15 million 2026 exclusion no federal estate tax arises; larger estates whose business exceeds 35% of the adjusted gross estate can use §6166 instalments or a §303 redemption to pay it.
  5. A revocable trust holding the shares lets a successor trustee act on incapacity and avoids probate, but gives no creditor protection, and the shares stay in the taxable estate.

MaterialsThe operating agreement, shareholders’ agreement or partnership agreement of a business you are studyingThe Supreme Court’s opinion in Connelly v. United States (2024), free on law.cornell.edu or supremecourt.govLesson 5.1.1, on estate and gift tax, and lesson 5.1.4, on life insurance trustsLesson 7.2.5, on voting trusts, and lesson 7.2.7, on trusts that hold operating companies

Wonder

  1. Who runs a family company the day after its founder dies, and who owns it?
  2. Why would co-owners agree in advance on who may buy a departing owner’s shares, and at what price?
  3. When a company collects life insurance on an owner, does that make the owner’s shares worth more?

Explore

  1. A closely held business, one owned by a few people and not traded publicly, can be thrown into difficulty when an owner dies or loses capacity. Shares pass under the owner’s will, trust or the state’s intestacy rules, so heirs who do not work in the business can become co-owners. A durable power of attorney can let an agent act for an owner who has lost capacity, but it ends at death. Succession planning has two separate parts: who will own the business (ownership succession) and who will run it (management succession). They are often different people.
  2. A buy-sell agreement is a contract among the owners, and often the company, that says what happens to an owner’s interest on events such as death, disability, retirement or divorce. It usually sets who may or must buy, how the price is fixed (a stated amount, a formula or an appraisal) and how the purchase is funded. It can give the estate a buyer and keep ownership with people the others accept. For US federal estate tax, IRC §2703 says a price in such an agreement is disregarded in valuing the interest unless the agreement is a bona fide business arrangement, is not a device to pass property to family members for less than full value, and has terms comparable to arm’s-length deals.
  3. There are two main forms. In a cross-purchase agreement, the surviving owners buy the departing owner’s interest themselves, often funded by life insurance policies they hold on each other. In an entity redemption (stock redemption) agreement, the company buys the interest back, often funded by insurance the company owns. Either way the surviving owners end up with larger percentage stakes. The forms differ in who owns the policies, who needs the cash, and in their tax results, including the buyers’ tax basis and, as Connelly shows, how the company is valued at an owner’s death.
  4. In Connelly v. United States, 602 U.S. 257 (2024), two brothers owned a building-supply company that held life insurance on each of them to fund a redemption. When Michael Connelly died, the company received about $3.5 million and paid $3 million for his shares. His estate argued that the duty to redeem offset the insurance proceeds. A unanimous Supreme Court, in an opinion by Justice Thomas, held that ‘a corporation’s contractual obligation to redeem shares is not necessarily a liability that reduces a corporation’s value for purposes of the federal estate tax’. The proceeds counted as a company asset, which raised the value of his shares, and the estate owed more tax.
  5. The Court noted that the brothers could have used a cross-purchase agreement instead, and said it was not holding that a redemption obligation can never reduce a company’s value. Trusts can also hold business interests. A revocable trust can keep shares out of probate and let a successor trustee act if the owner loses capacity, but it gives no protection from the owner’s creditors and the shares stay in the owner’s taxable estate. Shares given to an irrevocable trust may leave the estate, subject to gift tax rules. Voting trusts and voting and non-voting share classes can separate control from economic benefit.
  6. Valuation is often the hardest part. Appraisers of minority interests in closely held companies may apply discounts for lack of control and lack of marketability, because such interests are hard to sell and do not direct the company. The size of any discount depends on the facts, and the IRS and the courts often challenge it, so it is a common subject of dispute. For 2026 the US federal estate tax basic exclusion is $15 million per person; figures change with the law and by year.

Key facts

  • Succession planning covers both who will own a closely held business and who will run it; these can be different people.
  • A buy-sell agreement sets who may or must buy an owner’s interest on events such as death or disability, how the price is fixed and how the purchase is funded.
  • In a cross-purchase agreement the other owners buy the interest; in an entity redemption the company buys it back.
  • Under IRC §2703, an agreement price is disregarded for estate tax valuation unless it is a bona fide business arrangement, not a device to pass property to family for less than full value, and comparable to arm’s-length terms.
  • Connelly v. United States (2024) held unanimously that a company’s obligation to redeem shares does not necessarily reduce its value, so life insurance proceeds received by the company raised the value of the shares.
  • A revocable trust can help with incapacity and probate but gives no creditor protection, and its assets stay in the owner’s taxable estate.

Exercise nine, six, three, one

9CollectList up to 9 provisions of a buy-sell agreement or succession plan described in a case study or article you are reading (some have fewer), such as the triggering events, who buys, the price method, funding, management roles and dispute terms.
6ClusterSort them into 6 categories: triggering events, who buys, how the price is set, how the purchase is funded, who manages the business afterwards, and facts you are unsure about.
3DistillReduce the 6 categories to 3 groups: provisions about ownership, provisions about management, and provisions that affect valuation or tax.
1CrystallizeWrite 1 sentence explaining, in your own words, why the Connelly decision made the choice between a cross-purchase and a redemption agreement matter for estate tax.

Fact check

Dates, figures and claims checked against the published sources listed below.

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