Protect Your Business If a Key Person Is Lost

Key person insurance for professional practice answers one question: what happens to the firm if a partner dies? The policy pays a death benefit to the business, not to the partner’s family. The business then decides how to use the money to keep operations steady.

This guide explains how the coverage works, who can be insured, term versus whole life, and the tax questions to ask. It also explains how a coverage review with NR CPAs & Business Advisors, a Miami CPA firm, works. Insurance is offered through Nischay Rawal, a licensed insurance agent, separately from the accounting practice.

What key person life insurance is and who it fits

Key person life insurance is a policy a business owns on the life of someone whose death would hurt the business. The Insurance Information Institute describes key person coverage as a way to compensate a business for financial losses caused by the death of a key employee.

In a professional practice, the risk often sits with a few people. Clients may follow one partner. That partner may hold the main referral relationships or a niche skill. If that person is gone, revenue can drop fast, while rent, payroll and loan payments keep coming due.

This coverage usually fits partnerships and closely held practices where one or two owners produce a large share of income. That includes CPA, law, medical, dental and architecture firms. It also fits a firm where a partner’s death would strain bank credit lines.

Key person coverage is not a replacement for a partner’s personal life insurance. The policy belongs to the business and pays the business. A partner’s family may still need its own coverage.

What the policy pays for and what it covers

The policy pays a death benefit to the business, which is named as beneficiary. The business decides how to use the money under its own agreements and needs.

Common uses include:

• Replacing lost revenue while clients and staff adjust
• Recruiting and training a replacement partner or senior professional
• Repaying business debt or a credit line the loss could put under pressure
• Funding a partner’s share under a buy-sell agreement, when that agreement calls for it

A buy-sell agreement sets the terms for buying a partner’s ownership interest after death, retirement or departure. Florida’s partnership law sets a buyout price for a partner who leaves without dissolving the firm. The buyout price is tied to what the partner would receive if the firm’s assets were sold at the greater of liquidation value or going-concern value. Interest runs from the date of dissociation. See Fla. Stat. § 620.8701.

Key person life insurance pays on death. Disability needs call for a separate product. Limits and exclusions appear in the policy form, so read that form before you apply.

Who can be insured, and who is not eligible

Insurable interest rules are set by state law, so questions about who may own a policy on another person’s life are best discussed in a coverage review with our team.

They would also face a substantial financial loss from that person’s death. Whether a business may insure its owners, managers or key persons, and what written consent the law requires before a policy is bought, depends on the facts and the applicable rules. Contact us for a coverage review to go through those details for your situation.

Insurers set their own age limits and eligibility rules, and those vary by policy. In practice, a partner may not qualify if they refuse consent, fall outside the insurer’s issue ages, or carry no real business loss tied to their life.

Term or whole life: how to choose the policy type

Term life fits a set window. Whole life fits a longer need and builds cash value. Choose by the practice’s timeline and cash flow, not by premium alone.

Term life pays a level death benefit for a set number of years. Practices often match the term to the years a partner’s role matters most. They may also match it to the years left before a buy-sell agreement could be used.

Whole life is permanent coverage that builds cash value. Dividends are not guaranteed. Compare guaranteed and non-guaranteed values separately.

Permanent policies also face a federal test. A contract fails the 7-pay test if the amount paid in its first 7 contract years exceeds a set limit, and then it becomes a modified endowment contract. See IRC § 7702A.

The NAIC’s Life Insurance Buyer’s Guide covers term versus permanent coverage, how much to buy, and questions to ask before buying. Compare duration, premium pattern, cash value and the practice’s exposure window.

What it costs and how the tax rules apply

Cost depends on the insured’s age and health, the face amount, the policy type, the term length and the insurer’s underwriting. Premium alone does not show whether coverage makes sense.

Run a revenue-at-risk test before you buy. Add up:

• The partner’s annual revenue or production for the firm
• The cost to replace that revenue and recruit a successor
• Outstanding business debt that a loss could strain

Set that total against the premium and the length of the exposure.

Tax treatment depends on who owns the policy, who is beneficiary, and how the policy is set up. Under federal law, life insurance death proceeds are generally excluded from gross income. A transfer for valuable consideration limits that exclusion. For employer-owned policies, the exclusion is generally capped at the premiums and other amounts the policyholder paid, subject to exceptions. See IRC § 101.

Interest on debt tied to life insurance policies is generally not deductible. Under IRC § 101(a)(1), amounts received by reason of the insured’s death are generally excluded from gross income; the $50,000 key person indebtedness limit is not part of § 101 and is set out in IRC § 264. See IRC § 264.

Employer-owned contracts also carry a reporting duty. The policyholder must file a return showing employees insured and whether valid consent was obtained. See IRC § 6039I.

We answer these questions from the facts of your practice, working alongside your tax professional.

How the coverage review and purchase work, step by step

A coverage review starts with the practice, not the policy. Here is the usual path.

1. Describe the practice, its partners, and who drives the revenue.
2. Gather the partnership or operating agreement, buy-sell terms, financial statements and debt schedules.
3. Work through the coverage review to estimate revenue at risk and outline policy options.
4. Receive written disclosure of compensation and sign an engagement letter before work begins.
5. Complete the application, which includes health questions and the insured’s written consent. The insurer underwrites the file.
6. Once issued, set ownership, beneficiary and premium payments in writing.
7. Review the plan when partners join, leave or retire.

Fees for accounting and tax work are set in the engagement letter, which lists all variables.

Why NR CPAs & Business Advisors handles this coverage

NR CPAs & Business Advisors is a Miami CPA firm. It serves families, professionals and business owners across the United States, including Indian-American households and business owners and NRI clients.

Insurance is offered through Nischay Rawal, a licensed insurance agent, separately from the accounting practice. The firm ties the policy to the practice’s cash flow, partnership agreement and tax position.

Compensation for insurance is disclosed in writing before any engagement. Florida law says a CPA firm engaged in the practice of public accounting that accepts a commission for the sale of a product or service to a client must disclose that fact to the client in writing in accordance with rules adopted by the board. See Fla. Stat. § 473.3205. See Fla. Stat. § 473.3205. The firm offers no rebates or inducements to buy.

Our team handles document gathering and paperwork with the firm’s assistants and office staff.

Common questions before you decide, and the next step

The common questions cover what the policy pays, who qualifies, whether it is worth it, and what it costs. Key person insurance for professional practice is easiest to judge once you know these answers.