This is a life insurance policy that a company purchases on a key person’s (executive’s or employee’s) life. The insurance compensates the business for economic loss in case of the sudden demise of the key person. In other words, the company is the beneficiary of the plan and remits the insurance policy premiums.
A key person could be the owner of the business or employee with significant responsibility in the business. The company will face large negative effects in operations or overall gainful bottom-line in the event of sudden death of a key person.
The company informs the employee that it plans to purchase insurance on the employee and receives the employee’s written permission. The company then submits application for the policy and invariably, is the owner and beneficiary of the life insurance policy covering the key employee. The company receives the policy payoffs if the insured employee dies.
The company is the owner and beneficiary of the policy, consequently the premiums are not tax-deductible. Whenever the notice and consent requirements are followed, the proceeds paid to the business are generally excluded from federal income tax. If your company is a Corporation and you receive proceeds as the beneficiary, it could be liable to the corporate alternative minimum tax.
Additionally, when the proceeds are paid in installments, the interestsegment of each installment is taxable to the company. The insurance has no effect on the key employee unless the employee is also one of the company owners, especially when properly structured. Then the value of the demised owner’s stock or other business interest in his or her estate may be increased when the business receives the life insurance proceeds.
The key person insurance policy can demonstrate financial stability to creditors, or be used as collateral for a loan. The company can access the policy’s cash value for other purposes if the key person is still alive. The policy could help fund a buy-out of the demised person's business interest when the key persons are the owners. The key person insurance can be used to supply deferred compensation funds or retirement income for the key person when the policy isn’t needed to protect the business.