Connelly v. United States (23-146)

argument 23-146

Connelly v. United States

Supreme Court of the United States 53 min 7 speakers 8 chapters transcribed 8 days ago official recording ↗

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What is the core estate‑tax issue presented in Connolly v. United States?

John G. Roberts 0:00

We will hear argument next in Case 23-146, Connolly v. United States. Mr. Shanmugam.

Mr. Shanmugam 0:06

Thank you, Mr. Chief Justice, and may it please the Court. To ensure continuity in their operations, closely held corporations will often agree to redeem the stock of a shareholder upon his death and then obtain a life insurance policy on the shareholder in order to fund the redemption obligation. This case presents the question of how the Federal Estate Tax treats such arrangements. Because the proceeds from a life insurance policy to fulfill a contractual redemption obligation do not increase the corporation's net worth, they do not increase the estate tax owed on the decedent's stock. The Court of Appeals' contrary conclusion was erroneous. The legal framework governing this case is relatively straightforward.

Mr. Shanmugam 0:46

The Internal Revenue Code and Treasury regulations provide that where the parties agree on the price to redeem a shareholder's stock, that price will establish the value of the stock for purposes of the estate tax in certain circumstances. But where, as here, those circumstances have not been met, the value of the stock is determined by the price at which such stock would change hands between a hypothetical willing buyer and willing seller. Here, a hypothetical buyer would not treat the life insurance proceeds as increasing the value of the stock because that asset is offset by the contractual obligation to redeem shares, a pre-existing corporate liability. Now, the government argues that a court should attach no weight to the redemption obligation when assessing the value of the company.

Mr. Shanmugam 1:33

but the government fails to distinguish between a contractual obligation to redeem stock on the one hand and a voluntary stock redemption on the other. A hypothetical buyer would treat the contractual redemption obligation like any other debt that reduces the net worth and therefore the value of the company. The government's approach would lead to a grossly inflated valuation of the decedent's shares, and it would effectively lead to double taxation. It would defy common sense to take one side of the transaction into account, but to ignore the other for purposes of the estate tax. And it would destroy a valuable succession planning tool that the nation's small businesses have openly used for decades.

Mr. Shanmugam 2:11

The judgment of the Court of Appeal should be reversed. I welcome the Court's questions.

Clarence Thomas 2:15

Mr. Shanmugan, if a very interested buyer showed up the day after Michael died, would Thomas sell the business to him for $3.86 million?

Mr. Shanmugam 2:32

So if Thomas were the person we were thinking about and not Michael, I think it is quite possible that a hypothetical willing buyer would pay $3.68 million. No,

Clarence Thomas 2:44

I'm more focused on the asking price. If a buyer showed up the day after Michael died, and offered to buy it at any price, what would he sell it for?

Mr. Shanmugam 2:59

So I think it's important here to distinguish between Michael and Thomas.

Clarence Thomas 3:03

Which one died?

Mr. Shanmugam 3:04

Michael is the one who died. And Michael, of course, is the one whose shares would be subject to the $3 million. But

Clarence Thomas 3:12

Thomas is the, he is actually in charge of the estate and the company. So he's on both. So he can actually sell the property, right? Right.

Mr. Shanmugam 3:24

Yes, except for the fact that under the buy-sell agreement, Thomas is actually disabled from selling the

Clarence Thomas 3:30

property. Well, he has the first option.

Mr. Shanmugam 3:32

He has the first option. That is correct. But under the terms of the buy-sell agreement, the estate cannot sell

Clarence Thomas 3:38

the stock. Well, let me just blink that for a minute, okay? What would he ask for it, assuming he could sell it? Would he ask $3.86 million or $6.86 million, assuming that the insurance was included in the assets or liabilities of the company?

Mr. Shanmugam 4:01

Sure, Justice Thomas. So the first question is, what is the net worth of the company? Because we're in agreement with the government that that is the first question. Our view is that the net worth of the company throughout all of this is $3.86 million. The government's view is that the net worth of the company is $6.86 million, because in the government's view, you take into account the life insurance proceeds but not the offsetting redemption