Protect Your S Corporation Against the Loss of a Key Person

Key person insurance for an S corporation is a life insurance policy the company owns on an owner or key employee. The company pays the premiums and receives the death benefit if that person dies. This page explains who owns and who is insured, how the policy fits with a buy-sell agreement, and what the tax questions look like. Insurance is offered by Nischay Rawal, a licensed insurance agent, separately from the accounting practice of NR CPAs & Business Advisors, a Miami CPA firm.

What Key Person Insurance Is and Who It Is For

Key person insurance is life insurance a business buys on someone whose loss would hurt the company. The Insurance Information Institute guide describes it as coverage that pays a business for financial losses caused by a key employee’s death or disability.

In a small S corporation, one or two shareholders often hold the client relationships, the technical skill or the cash flow. If one of them dies, the company may lose income while it finds a replacement or reorganizes. A policy gives the business cash to bridge that gap.

This coverage fits three types of readers. Owners who run the company want to protect its income. Co-owners want to protect the business and each other. Families want to know what would happen to the company and the shares. Owners with cross-border ties, including NRI households, should bring those facts to the review.

The policy is usually whole life insurance or term life insurance. Each policy we discuss is issued by a specific insurer, which sets the policy form, the premiums and the terms. The insurer and policy form are named whenever a particular policy is presented. The NAIC Life Insurance Buyer’s Guide explains the difference between term and permanent coverage.

Ownership, Eligibility and the Buy-Sell Link

The company is usually the policy owner and the beneficiary. The insured person must agree in writing. Florida law lets a business insure its owners, officers, managers and key persons when it has an insurable interest in them. Written consent must be in place before the insurance is bought. See the Florida insurable interest statute.

Several groups are not eligible. A business without an insurable interest cannot buy coverage on another person’s life unless the benefits are payable to the insured or his or her personal representatives, or to any person having, at the time the contract was made, an insurable interest in the insured. The insurer can also decline a person after underwriting. Florida law bars a business from punishing a key person who refuses consent.

S corporation rules add another check. Under the IRC 1361 S corporation rules, a small business corporation generally cannot have a shareholder that is not an individual. Limited exceptions cover certain estates, trusts and organizations. Map the shareholders before the policy is set up.

A buy-sell agreement sets what happens to a deceased owner’s shares. Some companies use life insurance to fund the purchase. Florida recognizes shareholder agreements that follow the Florida shareholder agreement statute. The statute requires the agreement’s existence to be noted on each share certificate or information statement.

What the Policy Covers and How Proceeds Can Be Used

The policy pays a death benefit to the company, and the company decides how to use it. Review the policy form before you buy. Check the face amount, the premium payment period, and any change in face amount or premium. Also check the limitations and exclusions, and how renewal, cancellation and age-based changes work.

Term life insurance covers a set period. Whole life insurance adds a cash value component. Policy illustrations must show guaranteed and non-guaranteed values separately. Dividends, where a policy offers them, are not guaranteed.

Companies often consider these uses for proceeds:

• Covering lost revenue while the company recruits or reorganizes
• Paying down business debt tied to the insured person
• Funding a share purchase under a buy-sell agreement
• Steadying cash flow during a transition

Read the exclusions closely. Florida law says an incontestable clause bars only a contest of the policy’s validity. Insurers can still rely on Florida’s rule on excluded coverage for exclusions and restrictions.

Tax Treatment and Basis for S Corporation Owners

Tax results turn on the facts, so the company’s accountant should review premiums and proceeds before a policy is bought. Three rules are worth knowing from the start.

First, IRC 264 generally disallows deductions for interest on indebtedness with respect to life insurance policies the taxpayer owns covering any individual. A narrow exception allows interest on up to $50,000 of such indebtedness per insured key person, which for this rule means only an officer or 20-percent owner. The statute also limits how many individuals may be treated as key persons, and interest above a statutory rate limit is still not deductible.

Second, IRC 101 sets consent and notice rules for employer-owned policies that cover an employee.

Third, the IRC 6039I reporting rules require an employer-owned policyholder owning contracts issued after the date of the enactment of IRC 6039I to file a return. The return shows employee counts, insured counts, insurance in force, the policyholder’s name, address, taxpayer identification number and type of business, and whether valid consent exists for each insured employee.

Basis is a running figure tied to each shareholder’s stock. It matters because it affects how a later distribution or share sale is measured. Keep clear records of how premiums and proceeds are handled. The accounting practice can review those records with you.

How the Process Works: Steps and Timeline

A key person case moves from a conversation to a set of decisions. The time from application to issue is set by the insurer’s underwriting.

1. Coverage review. You describe the company, its owners, the insured person’s role, any buy-sell terms and the financial exposure.
2. Ownership and records mapping. We review who owns the shares, what the governing documents say, and how premiums and proceeds would be recorded.
3. Underwriting. The insurer asks health questions and may request a medical exam or records. Health questions are required, and issue may depend on insurability.
4. Policy selection. The licensed agent presents the insurer’s policy form, the plan type, the face amount, the premium payment period and the limitations and exclusions.
5. Application and issue. The application goes to the insurer. Under Fla. Stat. 627.404, written consent from the key employee or key person is required before the insurance is purchased.
6. Ongoing review. Review beneficiary designations, buy-sell funding and basis records whenever ownership, pay or the insured’s role changes.

Why Work With NR CPAs & Business Advisors on This Decision

NR CPAs & Business Advisors is a Miami CPA firm. It helps families, professionals and business owners choose and buy life insurance in the states where its responsible agent, Nischay Rawal, is licensed as an insurance agent. That includes term and whole life, key person and buy-sell coverage, and estate planning life insurance. The firm brings a CPA’s view of tax and cash flow to those decisions.

The insurance side and the accounting side stay separate. Nischay Rawal, a licensed insurance agent, offers the insurance. The accounting practice addresses the company’s tax position and records. Each side answers its own questions, and the two are reviewed together.

Florida law requires a CPA firm that accepts a commission on a sale to disclose it in writing to the client. The Florida CPA commission statute sets that rule. The firm offers no rebates or other inducements. Fees for accounting work, and the commission the licensed insurance agent receives on any policy, are disclosed in writing, with complete details of the compensation, in an engagement letter the client signs before the engagement begins.

Frequently Asked Questions

Next Step: Bring Your Company’s Ownership Questions to a Coverage Review

You may be reading this after a co-owner’s illness, a shareholder’s death, or while planning a transition. You may be trying to protect the company and the people tied to it. Start with three questions. Which owner’s life matters most to the business? How would a buy-sell agreement be funded? How will premiums and proceeds be recorded for basis?

Bring your buy-sell terms and ownership records to the meeting. To protect your loved ones and your company, contact the firm to set up a coverage review with Nischay Rawal, licensed insurance agent.