Keep Your Business Running If You Die

What Happens to Cash Flow in the Weeks After an Owner Dies

Payroll, rent, loan payments and supplier bills keep coming due after an owner dies. The company still has to pay them, even when the owner’s work stops.

Money coming in may slow down at the same time. Many small companies depend on one owner for key customer relationships, approvals, pricing decisions and daily direction. Customers may wait to see who is in charge. Projects may stall.

The company may also need cash before the estate or the ownership change is settled. That process can take time, and the business still has bills to pay during it.

This page answers one question: how do I keep my business running if I die? It shows where the cash-flow gap comes from and how key person life insurance is designed to help close it.

Why a Profitable Company Can Still Run Short of Cash

A company can show a profit on paper and still run short of cash when bills come due. Profit counts sales when they are earned, not when the money arrives.

A customer may take 60 days to pay an invoice. Inventory may sit on shelves before it sells. Meanwhile, payroll runs on a fixed schedule.

These costs often continue after an owner’s death:

• Payroll and payroll taxes
• Rent or lease payments
• Loan payments
• Insurance premiums
• Supplier invoices on set payment terms

Lenders may review a business after an owner’s death. Loan agreements differ, so the terms that apply to your company depend on your own contracts.

A company with a small leadership group can feel this gap faster. Fewer people are ready to step in, so the work of the missing owner falls on the team that remains.

How Key Person Life Insurance Works for a Company

Key person life insurance is a life insurance policy that a company owns on a person whose death would cause it financial harm. The Insurance Information Institute’s guide to life insurance for key employees describes it as compensation for a business’s losses from the death or disability of a key employee.

In most cases, the company is the owner and the beneficiary. The death benefit is paid to the company, not to the owner’s family. The company then decides how to use the money, such as covering payroll, paying debt or hiring a replacement.

Florida regulates how life insurance may be advertised. A business may insure an owner, director, officer, partner, manager or key person only if that person consents in writing before the policy is bought. The business may not punish a key person who says no. See Fla. Stat. § 627.404.

The policy is usually term life insurance or whole life insurance. Fla. Stat. § 627.404 reads: “(5) A contract of insurance upon a person, other than a policy of prepaid funeral contract; group life insurance; or group or blanket accident, health, or disability insurance, may not be carried out unless, on or before the time of entering into such contract, the person insured, having legal capacity to contract, applies for or consents in writing to the contract and its terms, except that any person having an insurable interest in the life of a minor younger than 15 years of age or any person upon whom a minor younger than 15 years of age is dependent for support and maintenance may obtain a policy of insurance on the minor.” The NAIC Life Insurance Buyer’s Guide explains the differences between term and permanent coverage. Each coverage review identifies the specific insurer and policy form.

Issue depends on underwriting and health questions. Fla. Stat. § 627.404 reads: “(5) A contract of insurance upon a person, other than a policy of prepaid funeral contract; group life insurance; or group or blanket accident, health, or disability insurance, may not be carried out unless, on or before the time of entering into such contract, the person insured, having legal capacity to contract, applies for or consents in writing to the contract and its terms, except that any person having an insurable interest in the life of a minor younger than 15 years of age or any person upon whom a minor younger than 15 years of age is dependent for support and maintenance may obtain a policy of insurance on the minor.”

A Worked Example With the Variables Stated

One way to size the need is to add up monthly fixed costs, multiply by the months you want to cover, and subtract the cash the business still collects. The figures below are hypothetical assumptions, not a prediction.

Assumptions:

• Monthly payroll: $60,000
• Monthly loan payments: $12,000
• Monthly rent: $8,000
• Total monthly fixed costs: $80,000
• Months to cover: 6
• Cash still collected each month, Scenario A: $50,000
• Cash still collected each month, Scenario B: $30,000

Step 1. Fixed costs for 6 months: $80,000 × 6 = $480,000.

Step 2 (Scenario A). Cash collected: $50,000 × 6 = $300,000. Shortfall: $480,000 − $300,000 = $180,000.

Step 3 (Scenario B). Cash collected: $30,000 × 6 = $180,000. Shortfall: $480,000 − $180,000 = $300,000.

The cash need in this example falls between $180,000 and $300,000. If payroll rises or collections fall, the range moves. Supplier bills and taxes are left out to keep the example short.

A death benefit would be sized to the company’s own numbers, not to a predicted result. This example does not show a premium. Premiums depend on the insured’s age, health and the policy form.

What the Death Benefit Can and Cannot Do

The death benefit gives the company cash. It cannot guarantee that the business stays profitable or keeps its customers.

Key person coverage and buy-sell agreement insurance do different jobs. Key person coverage helps fund the company’s losses. Buy-sell agreement insurance is designed to fund the purchase of an owner’s share under an agreement.

A key person policy works alongside a written succession and management plan. It does not replace one. The company should also review the coverage amount over time, because payroll and debt change.

Tax and Ownership Questions to Settle Before You Buy

Tax results depend on the facts, including who owns the policy, who is the beneficiary, and how the company is organized. Settle these questions before you buy.

Federal law does not allow a deduction for premiums on a life insurance policy if the taxpayer is directly or indirectly a beneficiary under it. When the company is the beneficiary, its premiums generally are not deductible. See 26 U.S.C. § 264.

Under 26 U.S.C. § 101, amounts received under a life insurance contract because of the insured’s death are generally not included in gross income, but exceptions apply. For an employer-owned life insurance contract, which is how many key person policies are held, the amount the business can exclude may not exceed the premiums and other amounts it paid for the contract, unless the notice, consent and other conditions in § 101(j) are met. Interest paid on proceeds held by the insurer is not excluded.

Under 26 U.S.C. § 2042, insurance proceeds are included in the gross estate to the extent the executor receives them, and also to the extent other beneficiaries receive them when the decedent held any incident of ownership in the policy, alone or with another person, at death.

Our CPA practice reviews your company’s tax and cash-flow position. Insurance is offered by the licensed agent separately from the accounting practice.

Next Step: Request a Coverage Review

A coverage review is the first meeting we hold on key person coverage. We look at your company’s revenue, payroll, debt and ownership.

If your business depends on your work, and payroll and loan payments would continue after your death, start by listing those monthly costs. Then reach out to our team at nrcpas.com/contact to request a coverage review. Any fee for a coverage review is disclosed in writing before work begins.

Nischay Rawal acts as a licensed insurance agent. Related pages include key person life insurance and buy-sell agreement insurance.

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