Keep Your Contracting Business Steady When a Key Person or Owner Is Lost

Your business partner has died, or a key worker can no longer work, and the jobs and payroll keep coming. This page explains how key person insurance and buy-sell funding life insurance can help a contractor business keep running and buy out an ownership share. In short, key person insurance pays the business when an essential owner or worker dies. A buy-sell agreement funded with life insurance gives the surviving owners cash to buy the departing owner’s share at a price the agreement sets.

This page covers the general mechanics for a Florida contractor business. It does not recommend a specific policy, insurer or structure.

Why contractors ask about key person and buy-sell funding

Contractors usually ask this when one owner’s death or disability would stop bids, crews and cash flow at the same time.

A contracting business often depends on one person. That person may hold the licenses, run the bids, know the customers and manage the crew. When that person can’t work, income can drop fast. Payroll, supplier bills and bonding needs keep coming.

The question often comes from someone other than the owner. A surviving partner may want to know how to buy out a late partner’s share. A spouse may be trying to understand what the business can cover. An adult child may be taking over a family company and looking for the paperwork.

Many owners wait until after a loss to ask. Planning early gives the owners time to set a price, decide who pays the premiums and write the rules down while everyone can still agree.

What key person insurance covers in a contractor business

Key person insurance is a life insurance policy the business owns and collects on when an owner or essential worker dies. The Insurance Information Institute describes it as compensation for a business’s financial losses from the death or disability of a key employee (Insurance Information Institute guide). Usually the business is both the owner and the beneficiary. How the money is used is the business’s decision.

Florida law sets rules on who may insure whom. A business has an insurable interest in the life, body, and health of its owners, directors, officers, partners, and managers, or of any affiliate or subsidiary’s owners, directors, officers, partners, and managers, and of its key employees or key persons, or those of an affiliate or subsidiary. That interest exists only if each person consents in writing before the policy is bought. A business may not retaliate against a key employee who refuses consent (Fla. Stat. § 627.404).

Tax questions come next. Under 26 U.S.C. § 101, amounts paid because of the insured’s death are generally excluded from income, subject to stated exceptions. The IRS notes that interest on those proceeds is taxable. Premium treatment is a business expense question a CPA reviews with the business’s records.

How buy-sell agreements are funded with life insurance

A buy-sell agreement is a written contract. It sets what happens to an owner’s share at death, disability or departure, and the price for that share. Life insurance is one way to fund that promise.

The agreement names who buys the share, the price or formula, and when payment is due. The insurance supplies cash at the owner’s death. The buyer doesn’t have to borrow or sell business assets to pay.

Two common structures work differently:

• Cross-purchase: each owner buys and owns a policy on each other owner.
• Entity redemption: the business owns the policies and buys the deceased owner’s share from the estate.

The price needs as much attention as the policy. Federal estate valuation of a decedent’s interest in a business looks at the net amount a willing buyer would pay a willing seller. It includes a fair appraisal of business assets, goodwill and earning capacity (26 C.F.R. § 20.2031-3). A formula that ignores goodwill may leave a gap between the insurance and the price.

If the business is a Florida partnership, state law sets a buyout rule for a partner who leaves without dissolving the partnership. Interest runs from the date of departure to the date of payment (Fla. Stat. § 620.8701).

Term or whole life for contractor funding needs

Term life insurance covers a set number of years. Whole life insurance covers the insured for life while premiums are paid, and it includes a cash-value feature. FINRA explains both types.

Term can fit an agreement that will be needed for a set period, such as until a planned succession. Whole life may fit a longer need, but it works differently and costs differently. Compare both using the same death benefit and the same payment period.

Ask for guaranteed and non-guaranteed values to be shown separately. Dividends, where a policy pays them, are not guaranteed. Any growth or cash-value illustration should show its limits with the same emphasis as its results.

The owners’ ages, health, the agreement’s length and monthly cash flow all shape the choice. A coverage review looks at them together, not one at a time.

Tax, cash flow and documentation questions a CPA reviews

A CPA starts with three questions. Who pays the premiums? Who owns each policy? Who is named as beneficiary? Those answers drive both tax and cash flow.

Tax treatment depends on the facts of the entity type, ownership and policy structure. The CPA reviews those facts with the client rather than giving a general answer.

Ownership also matters for estate tax. Federal estate tax can include life insurance proceeds payable to other beneficiaries when the decedent held an incident of ownership at death (26 U.S.C. § 2042). Ownership decisions are reviewed early for that reason.

Certain employer-owned policies carry reporting duties. Federal law requires a return for each year those contracts are owned.

Keep one written file with the agreement, consent forms, ownership and beneficiary records, and proof of premium payments.

Underwriting, health questions and what to gather first

Fully underwritten policies require health questions. Issue may depend on insurability. A medical history can affect which policy an insurer will issue and at what premium.

No review can predict an insurer’s decision. The first step is gathering facts. Pull together the buy-sell agreement or draft, ownership records and percentages, a list of current life and disability coverage, recent business financial statements, and any written consent forms for key persons.

Next steps with NR CPAs & Business Advisors

NR CPAs & Business Advisors is a Miami CPA firm that helps business owners and families review key person and buy-sell funding insurance.

If a partner’s death or illness has left you facing these questions, you may not be ready to decide anything yet. You can start by gathering the facts in this article.

Our coverage reviews carry a fee, and we explain all fee terms in writing before any engagement. Insurance is offered through Nischay Rawal, a licensed insurance agent, separately from the firm’s accounting practice. If a commission applies, Florida law requires the firm to disclose it in writing (Fla. Stat. § 473.3205).

For the broader guide, read our key person insurance guide. When you’re ready, contact NR CPAs to request a coverage review of your business’s funding needs.

Frequently asked questions