Key Person Insurance vs Buy-Sell Insurance in Florida

Key Person Insurance vs Buy-Sell Agreement: Where They Differ

Key person insurance helps a business cope with losing an essential person. A buy-sell agreement sets how an owner’s share is bought when an owner dies, leaves or becomes disabled, and life insurance can fund that purchase. The two plans often work together, but they answer different questions.

Key Person Insurance and Buy-Sell Insurance at a Glance

Key person insurance is life insurance that a business owns on someone it depends on. The business is the beneficiary, so the proceeds go to the company. The Insurance Information Institute describes this coverage as compensating a business for financial losses caused by the death or disability of a key employee.

Buy-sell insurance is life insurance used to fund a buy-sell agreement. That agreement is a contract among owners. It covers what happens to an owner’s share after a trigger event, such as death or retirement.

The core difference is simple. Key person coverage helps the business keep running after it loses a person’s work. Buy-sell coverage helps move an owner’s ownership interest to a buyer the owners agreed on.

Three questions separate the two plans. Whose life is insured? Who owns the policy and pays the premiums? Who receives the money? The sections below take each one in turn.

How Key Person Insurance Works

Key person insurance pays the business when an essential person dies or becomes disabled. The insured is someone whose loss would cost the company money, such as an owner, an executive or a top employee. The business usually owns the policy, pays the premiums and receives the proceeds.

Florida law sets a consent rule. A business entity can insure the life of its owners, officers, managers or key persons, but only if that person gives written consent before the insurance is bought. The business may not retaliate against someone who refuses.

Tax is the next question. Under 26 U.S.C. § 264, no deduction is allowed for premiums on a life insurance policy when the taxpayer is directly or indirectly a beneficiary under it. So when the business is the beneficiary, it cannot deduct the premiums. Under 26 U.S.C. § 101, amounts paid because of the insured’s death are generally excluded from gross income, though exceptions apply.

The business decides how to use the proceeds. Common uses include covering lost revenue, recruiting a replacement or steadying operations. The policy does not transfer ownership or set a price for an owner’s share.

How a Buy-Sell Agreement Works and Where Insurance Fits

A buy-sell agreement sets the rules for an owner’s exit before anyone needs them. It names the trigger events, such as death, disability, retirement or departure. It sets the price or the valuation method, and it says who may buy the departing share.

Price is where many owners get stuck. Under federal regulations, the fair market value of a business interest is the net amount a willing buyer would pay a willing seller. Factors include a fair appraisal of the business’s assets and its earning capacity. 26 C.F.R. § 20.2031-3 sets out these factors. A clear method written in advance leaves less to argue about later.

Life insurance supplies the cash. When an owner dies, the death benefit can complete the purchase, so the deal does not depend on the company’s operating cash. The heirs get a defined buyer.

The agreement must be specific enough to enforce. The Florida Supreme Court says a contract needs an offer, an acceptance, consideration and sufficient specification of essential terms. See St. Joe Corp. v. McIver. For a corporation, a shareholder agreement is effective under Florida’s corporation statute when it meets that statute’s requirements, such as being in writing, signed by all shareholders and made known to the corporation. For an LLC, except as otherwise provided in subsections (3) and (4), the operating agreement governs relations among the members and between the members and the company, under Fla. Stat. § 605.0105. Have the owners’ attorney draft the agreement.

Side-by-Side: Where the Two Plans Differ

Key person and buy-sell coverage differ in purpose, insured, owner and beneficiary. The table shows the usual pattern. Structure can change the answers, so read each row as typical, not fixed.

The number of policies differs too. A buy-sell plan is built around each owner’s share and the agreement’s terms. Key person proceeds are not tied to a buyout. Buy-sell proceeds are.

Cross-Purchase and Entity Redemption: How Ownership Changes the Plan

In a cross-purchase, each owner buys and owns a policy on each other owner. In an entity redemption, the business owns the policies and buys back the departing owner’s share. Who holds the policy changes who pays, who receives the money and how the estate tax analysis works.

Estate tax is one reason structure matters. Insurance receivable by or for the benefit of the estate is included in the gross estate, and insurance receivable by other beneficiaries is included when the decedent held incidents of ownership at death, alone or in conjunction with any other person. A corporation-owned policy can still count. 26 C.F.R. § 20.2042-1 addresses the circumstances under which incidents of ownership held by a corporation are attributable to a decedent through stock ownership, and points to its subparagraph (6) for the rules. This subsection covers policies held in trust. A decedent is considered to have an “incident of ownership” in an insurance policy on his life held in trust if, under the terms of the policy, he (either alone or with another person or persons) has the power (as trustee or otherwise) to change the beneficial ownership in the policy or its proceeds, or the time or manner of enjoyment thereof, even though he has no beneficial interest in the trust.

Transfers matter too. Under 26 U.S.C. § 101, when a policy is transferred for valuable consideration, the amount excluded from income for amounts paid by reason of the death of the insured cannot exceed the actual value of the consideration plus the premiums and other amounts subsequently paid by the transferee, unless an exception applies. This can come up when owners restructure who holds a policy.

Make sure the policy owner and beneficiary match the agreement’s structure. Owners should review the choice with their CPA and their attorney before they sign.

Do You Need a Key Person Policy, a Buy-Sell Policy, or Both?

Start with the risk that worries you most. If the business depends on one person’s skills, client relationships or licenses, key person coverage is the main question. If co-owners need an orderly way to handle a death, disability or departure, buy-sell coverage is the main question.

Many owner-managed businesses review both. One plan protects day-to-day operations. The other protects the transfer of ownership. Which one you need depends on your company’s facts, the owners’ roles and any agreement already in place.

Two mistakes are common. First, owners sign an agreement and buy policies without checking that the beneficiaries match the agreement. Second, owners assume the key person policy sets an owner’s buyout price. It does not.

Track premiums and proceeds separately, so each plan’s cash stays clear. Check beneficiary designations against the agreement’s terms on a regular schedule.

Key Takeaways and a Coverage Review for Your Business

Key person insurance protects the business from losing an essential person. Buy-sell insurance funds the purchase of an owner’s share under an agreement.

Before you decide, answer four questions. Who is insured? Who owns the policy? Who receives the proceeds? What does the agreement require?

Insurance is offered by Nischay Rawal, acting as a licensed insurance agent, separately from the accounting practice of NR CPAs & Business Advisors. Nischay Rawal is the responsible agent for this page.

If a co-owner’s illness or a planned departure has left your ownership split unclear, reach out to our team for a coverage review of your key person and buy-sell options.