Is the key person death benefit tax-free to the company?

Only if IRC §101(j) is satisfied. Before the policy was issued, the employee must have received written notice of the planned coverage, its maximum face amount and the company’s role as beneficiary, and consented in writing, including to coverage continuing after they leave; and one of the statute’s exceptions must apply — such as the insured being an employee within 12 months before death, or a director or highly compensated employee when the policy was issued. Otherwise the death benefit above premiums paid is taxable income. The company also reports the policy each year on Form 8925. If your business owns a policy and nobody remembers signing a consent, review it with your CPA now. IRS Notice 2009-48 allows relief for a missed notice and consent only if the company made a good-faith effort to comply (such as a formal system for new employees), the failure was inadvertent, and it was discovered and corrected no later than the due date of the company’s tax return for the year the policy was issued. A missing consent cannot be corrected after the insured has died.

Term or permanent for key person coverage?

Term insures the risk at the lowest premium and is the honest default for a pure lender requirement or a defined window — a key contract, a buyout runway. Permanent costs more but builds company-owned cash value and never outlives its usefulness the way a 10-year term does when the key person is still key in year 11. Many designs layer both: permanent base, term rider for the peak-exposure years.

Can key person insurance fund the employee’s retention package too?

Yes — and it’s one of the more elegant designs in the book. The same permanent policy that protects the company can informally fund a deferred-compensation or §162 executive bonus arrangement: golden handcuffs for the employee, protection for the business, one premium doing two jobs. Design and documentation matter; this is built with your CPA, not around them.

The Person Who IS the Business

If one funeral would sink the company, the company is uninsured.

Every closely-held business has at least one person whose death would stop revenue cold — the founder who holds the relationships, the rainmaker who holds the pipeline, the operator who holds the whole thing together. Banks know it: key-person coverage is routinely a lending condition. Most owners find that out at the loan closing, not the planning table.

Key person insurance is company-owned coverage on that person’s life. The business pays the premium, the business is the beneficiary, and the death benefit lands as liquidity in the exact quarter the company needs to replace revenue, calm the bank, recruit a successor — or wind down on the owners’ terms instead of a creditor’s.

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The §101(j) trap almost nobody flags

Since the Pension Protection Act of 2006, a death benefit from a company-owned policy on an employee is income-tax-free only up to the premiums paid unless two conditions are met: before the policy was issued, the employee received written notice of the planned coverage, its maximum face amount and the company’s role as beneficiary, and consented in writing, including to coverage continuing after they leave, and one of IRC §101(j)’s exceptions applies — for example, the insured was an employee within 12 months before death, or was a director or highly compensated employee when the policy was issued. The company also reports the policy each year on Form 8925. We design around §101(j) from day one and review existing policies that weren’t.

Premiums, honestly

Key-person premiums are not tax-deductible (IRC §264) — anyone who tells you otherwise is selling. The trade: after-tax premiums in, and a death benefit that is generally income-tax-free when §101(j) is handled. Its purpose for the business is liquidity at the insured’s death, on the policy’s terms.

Cash value works for the company too

Structured as permanent coverage, the policy builds cash value the business can access — a balance-sheet asset, borrowable for the slow season or the expansion, that doubles as an informal funding source for the key employee’s own retention package.

Asked Across the Desk

Key Person Insurance — the honest answers.

The working conventions are a multiple of the key person’s compensation or their share of revenue or profit contribution over a realistic replacement window — the years it takes to recruit, train, and season a successor. Lenders often set their own floor as a loan condition. We model it from your P&L, not a rule of thumb: what revenue actually walks out the door, and how long until it walks back in.

Other exposures

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