Protect Your Business When a Key Person Is Lost

A key person insurance coverage review checks whether the life insurance a business carries on an essential owner or employee matches the money the business would really lose. Key person insurance is life insurance the business owns on that individual, with the business named as beneficiary. This page covers what the policy pays for, how it differs from buy-sell and personal coverage, the tax questions, and how a review works.

NR CPAs & Business Advisors is a Miami CPA firm that serves businesses across Florida. Nischay Rawal is the licensed insurance agent responsible for this page.

What Key Person Insurance Is and Who It Is For

Key person insurance is a life policy a business owns on someone the company depends on. The business pays the premiums and receives the death benefit. The Insurance Information Institute describes it as compensation to a business for financial losses caused by a key employee’s death or disability.

Key individuals usually include:

• Majority or co-owners
• Senior executives
• Top revenue producers
• Employees whose skills or client relationships the business relies on

Closely held companies in Miami, Fort Lauderdale, Tampa, Orlando and Jacksonville often lean on one or two people. When that is true, one unexpected loss can strain payroll, client work and lender terms.

Florida sets a consent rule. Under Fla. Stat. § 627.404, a “key employee” or “key person” is an individual whose position or compensation is described in section 101(j)(2)(A)(ii) of the Internal Revenue Code. Being important to the business does not, by itself, meet that definition, and the business must also get that person’s written consent before the insurance is purchased. The business, or an affiliate or subsidiary, also may not retaliate or take adverse action against a key employee or key person who does not consent.

What the Policy Covers and How the Proceeds Are Used

The policy pays a death benefit to the business. The business decides how to use the money, within the policy terms and its own needs. Common uses include:

• Covering lost revenue while the company finds and trains a replacement
• Covering lost profit during a slow period
• Paying off business debt
• Meeting lender or creditor requirements

Read the limits before you rely on the policy. Florida requires every policy to become incontestable after it has been in force during the lifetime of the insured for 2 years from its date of issue, with exceptions for nonpayment of premiums and, at the insurer’s option, certain disability and accidental-death terms. See Fla. Stat. § 627.455. See Fla. Stat. § 627.455. Incontestability does not end exclusions. Under Fla. Stat. § 627.463, the clause only bars a challenge to the policy’s validity.

Every insurance contract must also give at least 30 days to pay a premium after the first, under Fla. Stat. § 627.453.

Health questions are required, and issue may depend on insurability. A fully underwritten key person policy is not a policy with no health questions. Ask for the premium schedule, renewability and any age-based change before you commit.

Key Person Insurance, Buy-Sell Coverage and Personal Life Insurance Compared

Key person insurance protects the business from losing a person. Buy-sell and personal life insurance protect ownership and family, so they answer different questions.

• Key person: the business owns the policy and receives the benefit to cover operating losses.
• Buy-sell: funds the purchase of an owner’s interest when that owner dies, on terms set by the buy-sell agreement.
• Personal life: the individual owns the policy, and the family usually receives the benefit.

Ownership also changes the tax picture. Under 26 U.S.C. § 2042, life insurance proceeds count in a decedent’s gross estate when they are receivable by the executor, or when they go to other beneficiaries and the decedent held incidents of ownership at death.

The Florida life insurance guide covers term, whole, universal and other policy types. Before choosing a structure, settle four questions: who owns the policy, who pays the premiums, who is the beneficiary, and what the proceeds must do.

Identifying Key Individuals and Sizing the Coverage

The right amount comes from the exposure the business can identify, not from a round number. Work through three steps:

1. List every person whose death or disability would cut revenue, client retention or the ability to meet obligations.
2. Estimate the exposure: lost profit during recruitment, replacement hiring and training, business debt, lender requirements and contract obligations tied to that person.
3. Compare that total with the amount already insured.

The NAIC Life Insurance Buyer’s Guide covers how much coverage to buy and the questions to ask before buying.

Age, health, coverage amount and policy type all shape cost. This page does not quote premiums. The review works out the cost for your facts.

Three common mistakes are coverage set long ago and never updated, a policy on the wrong person, and a gap between the amount insured and the exposure. Write down the analysis so you can revisit it when ownership, revenue or lending changes.

Tax and Cash Flow: The CPA View

Premiums are a recurring cash cost, and their tax treatment depends on who owns the policy and who benefits from it.

The Internal Revenue Code at 26 U.S.C. § 264(a)(1) says that premiums on any life insurance policy cannot be deducted when the taxpayer is, directly or indirectly, a beneficiary under that policy. When the business is the beneficiary, this rule is central to the premium question.

Section 26 U.S.C. § 6039I requires an applicable policyholder that owns one or more employer-owned life insurance contracts issued after that section was enacted to file a return, at the time and in the manner Treasury regulations prescribe, for each year it owns those contracts. The policyholder must also keep the records needed to show whether that section and section 101(j) are met.

Cash flow is the other half. Model each year’s premium against the budget, and check the cost if the policy stays in force for many years. The review identifies the tax questions that must be answered for your facts. The firm does not promise a particular tax result.

Insurance is offered by the licensed insurance agent, separately from the accounting practice.

How a Coverage Review Works, Step by Step

A key person insurance coverage review runs in five steps, from the facts about your business to a written summary.

1. Coverage review. The first meeting is a coverage review, set up with our team.
2. Gather the basics. Collect ownership structure, key individuals, revenue by person where known, business debt, and any lender or contract requirements.
3. Review existing policies. Check the insurer, policy form, face amount, premium, beneficiary, owner and exclusions.
4. Identify gaps. Compare the coverage amount with the exposure, with premium and tax questions explained in plain words.
5. Get the terms in writing. If a policy is recommended, you receive the insurer, policy form, premium, payment period, limitations, exclusions and renewability before any application. Health questions are answered on the application.

If a partner’s health has changed or a lender now wants a personal guarantee, you don’t have to sort out key person coverage alone. Contact our team to set up your coverage review.

Frequently Asked Questions