Should You Consider Key Man Insurance to protect your business?
Don’t worry, we are not going to be morbid. But we have to ask the question: what would happen if a key member of your small business was suddenly hit by a bus? Would your small business go out of business, leaving other managers and employees unemployed? That’s where key man life insurance and key man disability insurance comes in. But what is key man insurance? We’ll tell you what that is in a minute, but first an apology. Perhaps it should be called key person insurance these days, but everybody – even the insurance companies – call it key man insurance, so we’ll stick with that.
What is Key Man Insurance?
Many businesses, especially small businesses and family-owned businesses, have someone who could be described as the “key man.” The key man may be the small business’s founder or the family business’s patriarch. If he or she were to die or become disabled unexpectedly, the business would take a severe hit, possibly even going out of business. (Note that there can be more than one key man, but we will keep to the singular for clarity.)
So key man insurance is pretty simple, the business takes out a life insurance policy or disability insurance policy with the key man as the insured party and the business itself as the beneficiary. (Compare a traditional policy where the insured party takes out the policy and designates a beneficiary, typically the surviving spouse or children.)
Factors to Consider in Deciding if a Key Man Policy is Right for your Small Business
Here are some of the things you should consider in deciding if key man insurance is right for you. As small business accounting experts were can work through these points with you:
- Does your small business have a founder or other leader who is essential or very important to the small business’s success?
- Is your family business headed by a patriarch who is essential or very important to the family business’s success?
- Are there other officers or family members who would like to keep the business going if possible?
- Is the situation such that a life insurance payout could give the small or family business the time and cash flow needed to return to a profitable basis?
- Is the key man insurable? Like any other life insurance policy, a key man policy will only be issued to someone who meets the insurance company’s health requirements. A marginally healthy key man might be insurable but at a higher cost. (Note that there are some policies that don’t require a medical exam.)
If you answered yes to many of these questions, key man insurance may be right for your small business or family business.
What are the Tax Implications of Key Man Insurance?
We have some good news and bad news here. The good news is that when a premium is paid to the small business or family business it is not considered taxable income. But the Internal Revenue Service (IRS) giveth and the IRS taketh away. Because the payments by the company is not taxable, the IRS has decided that the insurance premium payments are not deductible as a business expense. You may think that the payments are a legitimate business expense – after all, the policy is purchased to protect the business, and we can’t disagree with you – but that is the IRS’ rule. In that regard, it is similar to personal life insurance policies, the payments are not deductible but the premium paid out is not taxable to the beneficiary. Incidentally, the IRS will be watching if you attempt to take out insurance policies on non-key employees. As tax accounting experts we can walk you through this complex issue.
There are many situations in which a key man life insurance or disability insurance policy may be right for your small business or family business. But there are some complexities to work through. As small business accounting and tax experts we can help you determine if insurance is right for your company, who you should insure, and how much he or she should be insured for.
If you’d like to learn more about tax laws and your business, we at Akif CPA are here to help. Learn about our services here.
Do you have unique issues or concerns not discussed in this blog then please contact us by email or phone. We are here to help.