When a Business Closes, What Happens to Key Person Insurance?

If you’re asking what happens to key person insurance when business closes, the policy owner makes the call. The policy doesn’t disappear when the company does. It stays a live contract until someone transfers it, surrenders it, lets it lapse or sells it. This page walks through those three paths in plain words, along with the tax and cash flow questions a CPA checks before the final return is filed. Nischay Rawal acts as a licensed insurance agent on insurance matters. Insurance is offered by the licensed agent, separately from the accounting practice of NR CPAs & Business Advisors, a Miami CPA firm.

Why the Policy Owner Decides What Happens Next

The policy owner decides which path is open, and the policy records show who that owner is.

Key person insurance is life insurance a business owns on someone it depends on, such as an owner, officer or key employee. The company usually pays the premiums and is usually the beneficiary. The Insurance Information Institute explains that this coverage compensates a business for financial losses caused by the death or disability of a key employee.

When a Florida limited liability company dissolves, it must wind up its affairs. It must pay or provide for its debts, settle its affairs and distribute its assets. A policy with cash value can be one of those assets. See Fla. Stat. § 605.0709 for the winding-up rules.

Start by reading three things: who owns the policy, who the beneficiary is, and what the operating agreement says. Those answers set which paths you can use. Don’t guess at them. Pull the actual policy documents.

Path One: Transfer the Policy to the Insured Owner

Transferring the policy to the insured person is a common path when that person wants to keep the coverage in force.

A transfer for money or other value has a tax limit. Under IRC section 101, the death benefit excluded from income after a transfer for valuable consideration may be limited to the actual value of that consideration plus later premiums and other amounts paid by the transferee, subject to the statute’s exceptions. The cap equals the actual value the buyer paid, plus the premiums and other amounts the buyer pays later.

The rule has exceptions. A transfer to the insured is outside the limit. So is a transfer to a partner of the insured, to a partnership in which the insured is a partner, or to a corporation in which the insured is a shareholder or officer.

Check every transfer against those exceptions before anything is signed. Whether an exception fits depends on the facts, including who holds which interest.

After the transfer, the new owner pays the premiums. That makes the next premium a personal cash flow decision. Plan that payment before the company sets its final distributions.

Path Two: Surrender or Cancel the Policy and What the Cash Value Means

Surrender means the owner asks the insurer to end the policy and pays out its current cash surrender value.

Florida defines a surrender as a voluntary surrender, at the owner’s request, before maturity, in exchange for the current cash surrender value. See Fla. Stat. § 627.4553. If an agent recommends surrendering a policy with cash value, and does not recommend using the money to buy another policy, Florida law requires written information first. That information includes, but is not limited to, the estimated surrender charge, any lost minimum interest rate guarantees, possible tax consequences, any forfeited death benefit, and a description of any other performance guarantees given up by the surrender.

Keep guaranteed and non-guaranteed values on separate lines of your worksheet. Dividends, where a policy pays them, are not guaranteed. An illustrated growth figure is not a promise.

A surrender can have an income tax result. The CPA works it out from the policy’s cost basis and the amount received, then carries the result into the final return.

Term policies work differently. Term life insurance generally has no cash surrender value. Cancelling it ends coverage without a cash payment. The NAIC Life Insurance Buyer’s Guide explains term and permanent life insurance side by side.

Path Three: Let the Policy Lapse or Sell It

A policy lapses when premiums stop and the grace period runs out, so the coverage ends.

Florida requires every insurance contract to give the insured a grace period of not less than 30 days to pay a premium after the first. The policy stays in force during that period. See Fla. Stat. § 627.453.

A sale is a separate transaction with its own tax reporting. Federal tax law has a “reportable policy sale” rule. It applies when the buyer has no substantial family, business or financial relationship with the insured apart from the policy. See IRC section 101. Have any sale reviewed before the price is agreed.

Whatever the route, record the lapse or sale on the books. The final balance sheet should show the policy’s status on the closing date.

Tax Results Your CPA Checks Before the Final Return

Each path produces its own tax result, so the CPA compares them side by side before the return is filed.

• Transfer: a transfer-for-value review under IRC section 101.
• Surrender: a gain or loss measured from the cost basis and the cash received.
• Lapse: the policy’s end recorded on the books.
• Sale: a gain or loss on the sale price, plus the required reporting.

Pull these records before the comparison: the policy form number, the premium payment history, the cost basis, the latest statement of values, the ownership and beneficiary forms, and any loan balance.

A policy loan changes the math. See Fla. Stat. § 627.458. Any loan still outstanding should be part of the surrender calculation.

If the company, as an applicable policyholder, owns one or more employer-owned life insurance contracts issued after the date of the enactment of this section, IRC section 6039I requires it to file an annual return. Check that too.

The Order of Steps Before the Company Files Its Final Return

Work through five steps in order, from confirming ownership to getting written confirmation from the insurer.

1. Confirm ownership and beneficiary. Use the policy documents and the operating agreement.
2. Request the current statement of values. Ask the insurer for guaranteed and non-guaranteed amounts, shown separately.
3. Choose the path and record the decision. Put it in the company’s written consent or minutes, as the operating agreement allows.
4. Calculate the tax result. Reflect it in the final return and in any liquidation distributions.
5. Notify the insurer and confirm status in writing. Do this before the books close.

Each step should finish before the next one starts. A decision based on an old statement can miss a change in values. Use the newest statement you can get.

Questions Owners Ask About Closing a Company With Key Person Coverage

The owner chooses a path, and that choice should be made before the books close.

Request a Coverage Review Before the Final Return Is Filed

If your company is winding down and a key person policy is still on the books, a coverage review can help you choose a path before the final return.

Maybe your company is closing, and a policy on a partner or key employee is still active. You need to decide whether to keep it, transfer it, surrender it or sell it. Each choice affects your taxes and your cash flow, and the timing matters.

Contact NR CPAs & Business Advisors to request a coverage review. Nischay Rawal acts as a licensed insurance agent on insurance matters, and the insurer on your policy is identified during the review.

Reach out through our contact page to start the conversation.