Last week, the U.S. Supreme Court heard oral arguments in the Connelly case, which involves the question of how corporate-owned life insurance (COLI) designed to fund the redemption of a deceased shareholder’s stock impacts the fair market value of the subject company and the value of the decedent’s gross estate. Two circuits say the proceeds should not be included in the valuation, but one circuit (in Connelly) says it should be included. SCOTUS agreed to hear the case to resolve the circuit split.

The petitioner (estate) and the government both agreed that the value of the company was $3.86 million. But the IRS said the insurance proceeds of $3 million used for the redemption should be added in, for a total value of $6.86 million—and that amount should be used as the basis for valuing the decedent’s interest for estate tax purposes. The “fundamental problem” with that, said the attorney for the petitioner, is double taxation—once from the estate tax and then as capital gains tax on the increase in the remaining owner’s shares.

‘Weird’ case: The justices had trouble with this case. Justice Brett Kavanaugh found it “extremely difficult” and “weird,” Justice Ketanji Brown Jackson said, “I’m trying to follow,” and Justice Elena Kagan remarked that “it’s a little bit hard for me to get this through my head.” Justice Clarence Thomas was trying to follow the money. Referring to the $3 million in insurance proceeds, he said that extra value “has to go someplace … why isn’t the appropriate valuation $6.86 million?” Because it’s offset by the liability to redeem the shares, the petitioner’s attorney said. But Justice Jackson wondered “whether the proceeds of the life insurance are really going out when they’re being used to redeem the shares.”

One observer said the justices seemed to favor the government’s position. “The justices often bend over backwards to favor the IRS in tax disputes like this, especially when they involve (relatively) wealthy taxpayers worrying about the estate tax,” writes Columbia University law professor Ronald Mann on the SCOTUS blog. “So, I wouldn’t be at all surprised to see a lopsided victory here for the IRS just a few months from now.”

However, the court seemed to be concerned that, if the government were to prevail, it would upend private-business owners’ efforts regarding continuity of ownership. They asked whether COLI was a common strategy to use for this purpose. The government attorney was not sure and noted that a cross-purchase arrangement would be more effective, where the parties themselves hold the life insurance policies, not the company. An amicus brief the U.S. Chamber of Commerce and National Federation of Independent Business filed in support of the petitioner said that a redemption agreement a life insurance policy financed is “commonplace” and that a decision for the government “threatens that legitimate, long-established tool.”

The court also wondered whether the IRS was seeing a pot of gold here. Would the agency be going after huge amounts of back taxes and penalties from other estates in the same situation? The government downplayed this, saying that the IRS is not seeing a lot of this issue coming down the pike.

You can listen to audio of the oral arguments (click here), and there’s also a transcript available (click here). The case is Connelly v. United States, 23-146.