The loss of a key employee can be devastating for any business. A top salesperson, the CFO, director of marketing, or the owner who manages everything all can be invaluable to the successful continuation of a small business. The financial toll a business may have due to the loss of a key person will negatively impact the succession plans of the owner.
The obvious solution to the potential problem of losing a key employee is to use key employee life insurance. In spite of the attacks from Congress and the media on corporate-owned life insurance, the need for pure key employee protection still exists, and the outlook for its continued use in appropriate situations is favorable.
But a financial advisor must keep abreast of the potential changes to COLI and other business-owned life insurance, including the impact of both federal and state law.
Key Employee Life Insurance and Taxes
Key employee life insurance is simply a life insurance policyon the life of an employeethat is owned by a business with the business as the sole beneficiary. The business controls the cash value as well as all other contractual rights to the policy. The individual insured in most states must consent to the purchase but has no interest or rights in the policy.
Under current tax law the life insurance premium is not income tax deductible to the business when the business is “directly or indirectly a beneficiary” of the policy. The death benefit is income tax-free but subject to the corporate alternative minimum tax (AMT) calculation if owned by a C-corporation. Cash value also grows income tax deferred but its net growth in a given year (cash value increase less premiums paid for that year) also is potentially subject to the corporate AMT.
Potential Federal Income Tax Changes
Our industry associations have worked diligently with the Senate Finance Committee members last year and most recently in early 2004 to educate them on the appropriate uses of COLI and all other business-owned life insurance. It is likely that the Senate and House will reconsider the COLI and key employee life insurance question this year. At the time of this writing there is much optimism that final legislation ultimately will preserve the benefits of business-owned life insurance for key employees.