Protect the business your family depends on

Key person insurance is a life insurance policy that pays a business if a key employee dies. In a family business, that key employee is often a parent, sibling, or relative who runs daily operations or brings in major clients. The policy is designed to help the business handle the financial loss.

If you own or work in a family business in Florida, this guide explains how key person insurance works, who should own the policy, and what the tax and consent rules are.

What is key person insurance?

Key person insurance is a life insurance policy that a business buys on the life of an employee whose work it depends on. If that person dies, the business receives the death benefit. The business can then use the money to cover lost income, pay debts, or hire and train a replacement.

The Insurance Information Institute’s guide to life insurance for key employees describes this coverage as compensation for financial losses caused by the death or disability of a key employee.

Who should own and be the beneficiary of the policy?

In most key person cases, the business owns the policy and is named as the beneficiary. That structure lines up the person who pays the premium with the person who receives the money.

Ownership affects taxes. No deduction is allowed for premiums on any life insurance policy, or endowment or annuity contract, if the taxpayer is directly or indirectly a beneficiary under the policy or contract (IRC § 264). Your CPA should review this before the first premium is paid.

Are key person insurance proceeds taxable?

Under IRC § 101(a), gross income does not include amounts received under a life insurance contract, whether in a single sum or otherwise, if the amounts are paid by reason of the death of the insured, except as otherwise provided in paragraphs (2) and (3), subsection (d), subsection (f), and subsection (j).

Interest is a separate issue. The IRS says interest paid on life insurance proceeds left with the insurer is taxable (IRS FAQ on life insurance proceeds).

Some business-owned policies also fall under federal employer-owned life insurance rules. Under IRC § 6039I, every applicable policyholder owning one or more employer-owned life insurance contracts issued after the date of enactment of this section must file a return, at such time and in such manner as the Secretary prescribes by regulation, showing for each year such contracts are owned. The return shows the number of its employees and the number of those employees insured under the contracts at the end of the year, and the total amount of insurance in force. It also shows that the policyholder has a valid consent for each insured employee or, if not all consents were obtained, the number of insured employees for whom consent was not obtained.

Does Florida require written consent for key employee coverage?

Yes. Under Florida law, a business can buy insurance on an owner, director, officer, partner, manager, or key employee if it gets written consent from that person before the insurance is bought (Fla. Stat. § 627.404).

The business also may not retaliate against a key employee who refuses to consent. Keep a signed record of each consent. The signature of the proposed insured on the application counts as written consent under the same statute.

How does buy-sell insurance fit with key person coverage?

Key person insurance protects the business from losing a key person. Buy-sell agreement insurance funds the purchase of an owner’s share when that owner dies. Many family businesses use both.

Florida law gives an individual who is a party to a contract to buy or sell a business interest an insurable interest in the life of each other party. That interest applies for the purpose of that contract only (Fla. Stat. § 627.404).

Why ownership matters for estate taxes

Who owns a policy can pull its value into an estate. Under IRC § 2042, the value of the gross estate includes the value of property receivable by beneficiaries other than the executor, to the extent of the amount receivable by all other beneficiaries as insurance under policies on the life of the decedent with respect to which the decedent possessed at death any of the incidents of ownership, exercisable either alone or in conjunction with any other person. IRC § 2042 reads: “For purposes of the preceding sentence, the term “incident of ownership” includes a reversionary interest (whether arising by the express terms of the policy or other instrument or by operation of law) only if the value of such reversionary interest exceeded 5 percent of the value of the policy immediately before the death of the decedent.”

Common mistakes family businesses make

• Skipping written consent. The consent must come before the policy is bought, not after.
• Naming the wrong owner. Ownership decides who pays premiums, who gets the money, and how the policy is taxed.
• Ignoring the buy-sell plan. A key person policy and a buy-sell policy often serve different purposes, and both should match the business’s written agreement.
• Assuming approval is automatic. Key person policies are underwritten. The insurer asks health questions, and issue can depend on the insurer’s underwriting.

What happens in a coverage review?

A coverage review is the first meeting with our team. It is where we look at the business, the key people, the ownership structure, and the goals for succession or a buy-sell plan.

Insurance is offered by Nischay Rawal, a licensed insurance agent, separately from the accounting practice of NR CPAs & Business Advisors. Our team supports the accounting and tax side of the work.

Our practice serves families and business owners in Miami, Fort Lauderdale, West Palm Beach, Orlando, Tampa, and Jacksonville. Our team also works with Indian-American households and NRI clients who need coverage in the United States.

Frequently asked questions