Key takeaways
- Life insurance is a funding mechanism inside a business plan, and the business obligation it funds is identified before any policy is structured.
- Section 264(a)(1) of the Internal Revenue Code disallows a deduction for premiums on a life insurance policy "if the taxpayer is directly or indirectly a beneficiary under the policy or contract."
- Section 101(a)(1) generally excludes death proceeds from gross income, subject to two limits that matter in business planning: the transfer-for-value rule in section 101(a)(2) and the employer-owned contract cap in section 101(j).
- Under section 101(j), the exclusion for an employer-owned contract is capped at premiums and other amounts paid unless a section 101(j)(2) exception applies and written notice and consent were given before the contract was issued; neither condition alone lifts the cap.
- The main business structures are key person coverage, buy-sell funding, executive bonus arrangements, split-dollar arrangements and corporate-owned or employer-owned coverage, with fully insured section 412(e)(3) plans and loan protection alongside them.
- Insurance rules on replacement, suitability, disclosure and free-look periods vary by state.
Published October 6, 2026 · Updated October 8, 2026
Short Answer: What Business Life Insurance Is and What It Does
Business life insurance is life insurance that a business, its owners or both buy to fund a specific business obligation, such as buying out a deceased owner's interest, absorbing the loss of a key person, funding an executive benefit or repaying a loan. The tax treatment depends on who owns the policy, who pays premiums and who is the beneficiary.
Business life insurance explained in one line: it is a funding mechanism inside a business plan, never the plan itself. The plan is the buy-sell agreement, the succession arrangement, the executive benefit or the loan; the policy is one way to put cash where that plan needs it at the moment an insured person dies. This page is the hub of Business Life Insurance, a site devoted to life insurance for businesses: closely held companies, partnerships, professional practices, owner-employees and the executives they employ. It maps each strategy, the ownership-to-beneficiary-to-tax chain that governs all of them, and the federal rules that most often decide the outcome.
How Business Life Insurance Works
Every arrangement starts with a business problem. A company may depend on one rainmaker whose death would cut revenue, two owners may have signed an agreement promising to buy each other out, or an employer may want to reward a particular executive outside a qualified plan. Only after the problem is defined does the question of a policy arise: how much cash is needed, when, and in whose hands.
The three roles
A life insurance policy used in business involves three roles, and the same person or entity may fill more than one:
- The policyowner holds the contract's rights: naming the beneficiary, changing the contract within its terms and, on a permanent policy, accessing the cash value.
- The premium payor pays the cost of the coverage. The payor may be the owner, the business on the owner's behalf, or an employer paying as compensation.
- The beneficiary receives the death proceeds.
Each role carries tax weight. Who is the beneficiary decides whether section 264(a)(1) denies a premium deduction; who owns the policy, and whether that owner is an employer insuring an employee, decides whether section 101(j) applies; and who acquired the policy, and how, decides whether the transfer-for-value rule applies.
Policy types
Both term and permanent contracts appear in business planning. Term insurance provides a death benefit for a stated period. Permanent insurance, such as whole life or universal life, is designed to remain in force for the insured's life if its terms are met, and it builds a cash value: an amount within the contract that the owner may borrow against or withdraw under the contract's terms. Cash value is a contract feature, not an investment or a savings account, and how it accumulates varies by contract and by insurer.
How proceeds are used
At death, the proceeds are usually paid in a lump sum to the beneficiary, who applies them to the obligation the plan defined: paying a deceased owner's estate for the business interest, replacing revenue or recruiting a successor, retiring a loan, or delivering a benefit to an executive's family. The general income-tax rule is in 26 U.S.C. § 101(a)(1), which provides that "gross income does not include amounts received (whether in a single sum or otherwise) under a life insurance contract, if such amounts are paid by reason of the death of the insured," except as otherwise provided in the same section.
Who Business Life Insurance Is For
The reader of this site is usually a person with a stake in a business that would feel a death: an owner, partner, shareholder, managing principal, or a finance or human-resources lead. The arrangements described here are commonly structured for:
- Closely held corporations, both S and C corporations, where a handful of shareholders own and run the company.
- Partnerships and LLCs, where the owners' agreement governs what happens to an interest when an owner dies.
- Professional practices in law, medicine, accounting, dentistry and engineering, where revenue often follows particular individuals. Professional-licensing and ownership rules, including who may own a practice or keep an interest after a death, vary by state and are not addressed here. A profession-specific example is the site's treatment of life insurance for law firms.
- Businesses with two or more owners who want a funded exit mechanism, so that surviving owners keep control and a deceased owner's family receives value.
- Businesses that depend on one or a few individuals whose loss would impair sales, operations, credit or client relationships.
- Employers offering executive benefits to attract or retain particular employees on a selective basis.
- Borrowers with SBA loans. Whether an SBA loan involves life insurance turns on how fully the loan is secured and on who the principals are, as the section on business loan and SBA protection below sets out.
When Business Life Insurance May Fit
Fit is a question of facts, and certain facts recur.
A buy-sell agreement exists or is being drafted. A buy-sell agreement is a contract among owners, and sometimes the business, setting the terms on which an interest will be bought when an owner dies or leaves. Owners who want the purchase price available at death often fund the agreement with insurance, in one of three common patterns: cross-purchase (owners buy from each other), entity purchase or redemption (the business buys the interest), or a "wait-and-see" design that leaves the choice of buyer until the triggering event.
A key person's death would cause a measurable loss. Where revenue, a credit relationship or operations depend on one person, the loss can be estimated: revenue disruption, the cost of recruiting and training a successor, or a lender's right to accelerate a loan.
An employer wants a selective benefit outside a qualified plan. Qualified retirement plans carry broad coverage rules; an employer wanting to benefit a specific executive often looks to arrangements in which the employer pays or shares the cost of a policy.
A business sponsors, or is considering, a fully insured defined-benefit plan. Section 412(e)(3) describes a defined-benefit plan funded exclusively with individual insurance contracts. The IRS page on these plans states that before the Pension Protection Act of 2006 they "were known as '412(i) plans.'"
A loan carries a collateral assignment request. A collateral assignment is an assignment of a policy's proceeds to a lender as security, so the lender is repaid first at the insured's death. Whether a lender asks for one depends on the loan and the lender's policy.
When Business Life Insurance May Not Fit
Some facts point the other way. Where the business has no defined obligation for insurance to fund (no buy-sell agreement, no meaningful dependence on one person, no executive benefit program, no lender request), a policy has nothing to attach to.
Expectations about deductions are another common mismatch. A business that will be the direct or indirect beneficiary of a policy, and assumes it will deduct the premiums, is working against section 264(a)(1), which disallows that deduction.
Employer-owned contracts that miss the section 101(j) requirements are a third. When no section 101(j)(2) exception applies, or written notice and consent were not given before issue, the exclusion for the death benefit is capped at the premiums and other amounts paid.
Transfers present a fourth. A policy sold or otherwise transferred for value between owners, or to an outside party, without fitting an exception in section 101(a)(2) may lose part of its exclusion.
Finally, a business whose entity type or ownership is changing (a conversion, a new owner, a departure, a sale) may find that policy ownership, beneficiary designations or the applicable tax regime no longer match the plan. Premium deductibility, section 101(j) notice and consent and its information reporting, transfers between owners, executive bonus reasonableness, split-dollar regime and taxation, section 412(e)(3) design, business valuation, lender collateral requirements and estate inclusion of business-owned coverage each need individual review of the contracts involved, by the insurers and a qualified tax professional.
Ownership, Premiums and Beneficiary: The Structural Foundation
Ownership, payment and beneficiary designation are the three dials that set the outcome of every structure on this site.
Ownership
The owner controls the contract. Depending on the plan, the owner may be the business entity (key person, entity-purchase buy-sell, employer-owned coverage), an individual owner (cross-purchase buy-sell), an executive (executive bonus) or, in some designs, a trust. Trust ownership for personal estate planning belongs to a different subject; the business question here is limited to estate liquidity for a closely held business interest. Ownership also decides whether a contract is "employer-owned": IRS Notice 2009-48, A-1, states that "a contract that is owned by the owner of an entity engaged in a trade or business (such as for purposes of financing the purchase of an equity interest of another owner)... is not an employer-owned life insurance contract."
Premium payment
Who pays, and in what capacity, determines how a premium is characterized: an outlay the payor cannot deduct, a business expense, or compensation to an employee. The starting rule is 26 U.S.C. § 264(a)(1): "No deduction shall be allowed for— (1) Premiums on any life insurance policy, or endowment or annuity contract, if the taxpayer is directly or indirectly a beneficiary under the policy or contract."
The Treasury regulation, 26 C.F.R. § 1.264-1(a), extends the point. Premiums "are not deductible... even though they would otherwise be deductible as trade or business expenses, if they are paid on a life insurance policy covering the life of any officer or employee of the taxpayer, or any person (including the taxpayer) who is financially interested in any trade or business carried on by the taxpayer, when the taxpayer is directly or indirectly a beneficiary of the policy." Under § 1.264-1(b), a taxpayer that takes out a policy "for the purpose of protecting himself from loss in the event of the death of the insured" is a beneficiary directly or indirectly. The same paragraph adds that if the taxpayer is not a beneficiary, premiums "will not be disallowed as deductions merely because the taxpayer may derive a benefit from the increased efficiency of the officer or employee insured."
Beneficiary
The beneficiary designation sorts arrangements into families. The business as beneficiary (key person, employer-owned coverage) brings section 264(a)(1) and often section 101(j) into play. An executive's chosen heirs as beneficiary (executive bonus) shifts the analysis to compensation. A co-owner as beneficiary (cross-purchase) places the policy in the owners' hands rather than the employer's.
Changing any of the three dials after issue (a new owner, a new payor, a new beneficiary) can change the tax treatment, which is why such changes turn on the specific contracts involved.
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Federal Tax Treatment of Business Life Insurance
The Code reaches business life insurance at two points: when premiums are paid and when proceeds are received. Premium deductibility under section 264(a)(1) has already been set out with ownership and payment; the rules below govern the proceeds and the specialized arrangements.
The death benefit exclusion and its limits
Section 101(a)(1) states the general exclusion for amounts paid by reason of death. It applies "except as otherwise provided" in paragraphs (2) and (3), subsection (d), subsection (f) and subsection (j). Two of those exceptions drive most business planning.
Transfer for value: section 101(a)(2)
Section 101(a)(2) provides that "in the case of a transfer for a valuable consideration, by assignment or otherwise, of a life insurance contract or any interest therein, the amount excluded from gross income... shall not exceed an amount equal to the sum of the actual value of such consideration and the premiums and other amounts subsequently paid by the transferee." The limit does not apply, under section 101(a)(2)(A), where the transferee's basis is determined in whole or in part by reference to the transferor's basis, or, under section 101(a)(2)(B), where the transfer is "to the insured, 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." Section 101(a)(3) separately removes those exceptions for a "reportable policy sale," an acquisition by a person with "no substantial family, business, or financial relationship with the insured" apart from the policy interest. Selling a policy to an outside buyer is a separate subject this site does not develop.
The list matters in practice. A co-shareholder in a corporation does not appear on it, although the corporation itself does. A partner of the insured does.
Employer-owned contracts: section 101(j)
Section 101(j)(3)(A) defines an "employer-owned life insurance contract" as one owned by a person engaged in a trade or business, under which that person (or a related person) is directly or indirectly a beneficiary, covering an insured "who is an employee with respect to the trade or business of the applicable policyholder on the date the contract is issued." For such a contract, section 101(j)(1) provides that the exclusion "shall not exceed an amount equal to the sum of the premiums and other amounts paid by the policyholder for the contract."
The cap is lifted only when two things are both true. First, a section 101(j)(2) exception applies, either:
- an insured-status exception: the insured was an employee at any time during the 12-month period before death, or, at the time the contract is issued, is a director, a highly compensated employee, or a highly compensated individual, as those terms are defined for purposes of section 101(j)(2)(A)(ii); or
- an heirs exception: the amount is paid to a family member of the insured, a designated beneficiary other than the policyholder, a trust for such a person, or the insured's estate, or is used to purchase an equity, capital or profits interest in the policyholder from such a person.
Second, the notice and consent requirements of section 101(j)(4) were met "before the issuance of the contract": the employee "is notified in writing that the applicable policyholder intends to insure the employee's life and the maximum face amount for which the employee could be insured," "provides written consent to being insured under the contract and that such coverage may continue after the insured terminates employment," and "is informed in writing that an applicable policyholder will be a beneficiary." An exception without notice and consent does not lift the cap, and notice and consent without an exception does not either.
IRS Notice 2009-48, in its answers A-1, A-3, A-5, A-7 and A-13, states the following:
- Who is an employee (A-5). Section 101(j)(5)(A) "provides that the term 'employee' includes an officer, director, and highly compensated employee." A director is an independent contractor in that capacity, and section 414(q) contains special rules for certain former employees and self-employed individuals.
- Partnerships and sole proprietors (A-3). If a contract is otherwise described in section 101(j)(3), "ownership of the contract by a partnership or sole proprietorship does not prevent the contract from being treated as an employer-owned life insurance contract," but a contract "owned by a sole proprietor on his or her own life is not."
- Owner-owned contracts (A-1). A contract owned by an entity's owner to finance buying another owner's interest is not employer-owned.
- Wholly owned corporations (A-7). There is no exception "that would excuse a wholly-owned corporation and its employee-owner from the notice and consent requirements," and actual knowledge cannot substitute for written notice and consent.
- Inadvertent failures (A-13). Section 101(j) has no correction provision, but the IRS states it will not challenge an exception on account of an inadvertent failure if the policyholder made a good faith effort, the failure was inadvertent, and it was discovered and corrected no later than the due date of the tax return for the year the contract was issued. Because consent must be written, a failure "cannot be corrected after the insured employee has died."
These answers are those of Notice 2009-48 as published in 2009. Employers holding employer-owned contracts also have federal information-reporting obligations, which turn on the contracts held.
Executive bonus premiums: section 162(a)(1)
"Section 162 plan," "executive bonus plan," "restricted executive bonus arrangement" (REBA) and "double bonus" are industry terms. None is a qualified plan, and none is a term defined in the Internal Revenue Code or Treasury regulations. In these arrangements the executive owns the policy and names the beneficiary, and the employer pays the premium as additional compensation. Because the employer is not the beneficiary, the section 264(a)(1) bar is not the operative question; the employer's deduction is analyzed under 26 U.S.C. § 162(a)(1), which allows "a reasonable allowance for salaries or other compensation for personal services actually rendered." The bonus is taxable compensation to the executive, and whether total compensation is reasonable depends on the facts.
Split-dollar arrangements
Split-dollar is an arrangement in which an employer and an employee (or another party) divide a policy's premium costs and benefits. For arrangements entered into after September 17, 2003 (or materially modified after that date), Treasury regulations tax these arrangements under one of two regimes: an economic benefit regime, in which the economic benefits provided to the party not owning the policy, such as current life insurance protection, are taken into account by that party, reduced by any consideration it pays for them, and a loan regime, in which a premium payment that qualifies as a split-dollar loan is treated under the rules for loans. Which regime applies depends on who owns the policy and how the arrangement is structured. "Equity" and "non-equity" split-dollar are industry labels, not regulatory terms. IRS Notice 2002-8 requested comments on "the appropriate rates for valuing current life insurance protection," a central measurement question in these arrangements.
Fully insured section 412(e)(3) plans
A section 412(e)(3) plan is a fully insured defined-benefit plan, not an insurance deduction strategy. 26 U.S.C. § 412(e)(3) describes a plan in which:
- (A) the plan is "funded exclusively by the purchase of individual insurance contracts";
- (B) the contracts provide for level annual premiums from the date the individual became a participant to no later than retirement age;
- (C) plan benefits equal the benefits under each contract at normal retirement age and, under the statute's terms, are backed by a state-licensed insurance carrier to the extent premiums have been paid;
- (D) premiums for the plan year and all prior years have been paid before lapse, or the policy has been reinstated;
- (E) no rights under the contracts have been subject to a security interest during the plan year; and
- (F) no policy loans are outstanding during the plan year.
The statute also treats a plan funded exclusively by group insurance contracts as a plan described in section 412(e)(3) if regulations determine that those contracts have the same characteristics as the individual contracts described above. The IRS page on these plans states that the former section 412(i) provisions were relocated to section 412(e)(3) "effective for plan years beginning after December 31, 2007," that the plans "are exempt from the minimum funding rules," and that if an employer deducts premiums on a contract whose death benefit exceeds the participant's plan death benefit "by more than $100,000, the arrangement is a 'listed transaction.'" Contributions are deductible only within the Code's limits on deductions for plan contributions, and benefits are subject to the Code's limits on defined-benefit plan benefits.
What Affects the Amount of Coverage and Its Cost
No formula sets the amount. It comes from the obligation being funded, and the inputs differ by structure.
Key person coverage. Planning inputs typically include revenue attributable to the person, the cost of recruiting and training a successor, and debt that a lender could accelerate on the person's death. These are business estimates, not a coverage rule. The tax side of this structure is covered on the site's page on key person insurance deductibility.
Buy-sell funding. The amount usually tracks the agreed or appraised value of each owner's interest under the agreement. Closely held business value is not fixed, so the figure depends on the business's facts and on the valuation method the agreement uses.
Executive bonus. The employer sets the benefit; the premium is the cost of the underlying policy, and the bonus may be sized to cover it.
Underwriting. The insured's age, health and occupation, and the type of policy, affect whether coverage is offered and at what cost. Underwriting standards, forms and charges vary by insurer and are confirmed with the insurers involved.
Policy type. Term coverage pays a death benefit for a defined period. Permanent coverage builds a cash value as a contract feature.
State insurance rules on replacement, suitability and disclosure also shape how a policy is sold and documented, and these rules vary by state.
Common Business Life Insurance Structures
What follows is the site's strategy map. Each entry names the business problem, the ownership-beneficiary pattern and the rules that attach; the site treats each one in depth on its own pages.
Key person insurance
Also called key man or key employee insurance, this structure protects the business against the financial loss of an individual. The business owns the policy, pays the premiums and is the beneficiary; proceeds may replace lost revenue or fund a search for a successor. Section 264(a)(1) disallows the premium deduction, and if the insured is an employee, section 101(j) applies to the proceeds.
Buy-sell agreement funding
Here the problem is an ownership transition. In a cross-purchase, each owner owns a policy on the other owners and is its beneficiary; the site's page on cross-purchase buy-sell agreements walks through that design. In an entity purchase or redemption, the business owns a policy on each owner and buys the deceased owner's interest. Wait-and-see designs combine elements of both. Proceeds fund the purchase of the deceased owner's interest. When policies are later reassigned between owners or to the business, the transfer-for-value rule comes into play. The site also covers succession and continuity funding more broadly, including estate liquidity for a closely held business interest.
Executive bonus arrangements
These industry-named arrangements (section 162 plans, REBAs, double bonus designs) provide a selective benefit. The employer pays the premium as compensation; the executive owns the policy and names the beneficiary. The employer's deduction rests on the reasonableness of total compensation under section 162(a)(1), and the bonus is taxable to the executive. A REBA adds an agreement restricting the executive's access to the policy for a period; the terms of that restriction come from the agreement, not from any statute.
Split-dollar life insurance
This structure is used by employers and executives who want to share a policy's cost and benefits; at least one party paying premiums is entitled to recover all or part of them from the policy's proceeds. It falls under either the economic benefit regime or the loan regime, depending on ownership and structure.
Corporate-owned and employer-owned life insurance
COLI and EOLI refer to policies an employer owns on employees with the employer as beneficiary, sometimes covering a group of employees and sometimes informally matched to benefit liabilities. Section 101(j) definitions, exceptions and notice and consent govern the proceeds, and federal information reporting applies to employers holding these contracts.
Fully insured section 412(e)(3) plans
This is a qualified defined-benefit plan funded exclusively with insurance contracts that meet section 412(e)(3)(A) through (F), formerly known as a 412(i) plan. Deduction and benefit limits apply, and the listed-transaction rule described in IRS guidance applies to excess death benefits.
Business loan and SBA protection
This structure protects a lender, and indirectly the business and the owner's family, against an owner's death while a loan is outstanding, usually through a collateral assignment of an existing or new policy. For a standard 7(a) loan, SBA SOP 50 10 8.1 (effective October 1, 2026) lets the lender follow its internal policy for similarly sized commercial loans without an SBA guarantee; the SBA's own life insurance condition applies where the loan is not fully secured and the principal is a sole proprietor, a single-member LLC owner, or the business depends on one owner's active participation, in the amount of the collateral shortfall.
Potential Advantages of Business Life Insurance Arrangements
Liquidity at the right moment is the advantage that runs through most structures. A funded buy-sell agreement can put the purchase price in the buyer's hands at an owner's death, so that surviving owners or the business need not sell assets or borrow to meet the obligation. A deceased owner's family can receive value for the interest, and the survivors can keep control.
Key person coverage can provide a cash payment to absorb the disruption that follows the loss of a revenue-producing or operationally critical person, buying time to recruit, reassure lenders and retain clients.
Executive bonus arrangements allow an employer to provide a selective benefit outside a qualified plan, with the employer's deduction governed by section 162(a)(1) reasonableness and the executive holding the policy outright.
Employer-owned coverage, when the section 101(j) conditions are both satisfied, keeps the section 101(a)(1) exclusion available to the employer. Some employers use such coverage as an informal source of funds for benefit obligations to employees.
A section 412(e)(3) plan is designed to provide defined retirement benefits funded entirely by insurance contracts, within the Code's limits on deductions and benefits, and is exempt from the minimum funding rules of section 412, according to the IRS.
Each of these is an outcome the rules can produce when the facts fit them, not a result any particular business can count on.
Important Considerations and Risks
Compliance details, not product features, are where most arrangements go wrong.
No deduction when the business benefits. For key person and employer-owned coverage, the business is the beneficiary, so section 264(a)(1) and 26 C.F.R. § 1.264-1 deny the premium deduction.
The section 101(j) cap. When an employer-owned contract lacks either a qualifying exception or written pre-issue notice and consent, death proceeds above the premiums and other amounts paid are included in gross income. Under Notice 2009-48, A-13, the relief for inadvertent failures has conditions and a deadline, and it is unavailable after the insured's death.
Transfer for value in restructurings. Moving from cross-purchase to entity purchase, adding an owner or buying out a departing owner's policies can involve transfers for value. Whether an exception in section 101(a)(2) covers a transfer turns on the transferee's relationship to the insured or on how the transferee's basis is determined.
Split-dollar regime. Applying the wrong regime, or changing policy ownership mid-arrangement, can change how the arrangement is taxed.
Valuation drift. A buy-sell agreement funded at a value set years earlier may leave a gap between the proceeds and the price, or produce disputes over the price itself.
Executive bonus reasonableness. The employer's deduction depends on whether the executive's total compensation is reasonable under section 162(a)(1).
State rules. Replacement, suitability, disclosure and free-look rules vary by state, and the insurers involved confirm which apply.
Alternatives to Business Life Insurance for the Same Objectives
Insurance is one funding source among several. Each of the alternatives below addresses the same business problems with different trade-offs.
A sinking fund. The business or the owners set aside cash over time to fund a future buyout. No premium is paid, but income on the fund is generally taxable, and the fund may be too small if a death comes early.
An installment purchase. The buyer pays a deceased owner's estate over time under the agreement. No advance funding is needed, but the buyer carries an ongoing cash-flow obligation and the estate carries credit risk.
Bank financing. A surviving owner or the business borrows the purchase price at the time of need. Interest is a cost, and approval depends on creditworthiness at that moment, often right after the business has lost an owner.
Qualified plan death benefits. A qualified retirement plan may pay a death benefit, but plan benefits are subject to the Code's limits and distribution rules and are generally taxed as income when distributed, and they belong to the participant's beneficiaries rather than to the business plan.
Where an existing personal policy is being considered for a business purpose, questions such as an exchange of one contract for another or converting term coverage belong to separate subjects and turn on the policy's own terms.
Hypothetical Example: Funding a Two-Owner Buy-Sell Agreement
This example is hypothetical. It uses round figures, it rests on the assumptions listed, and it does not describe any reader's own business, contract or tax result.
Assumptions.
- A business has two unrelated owners, A and B, each holding 50 percent.
- The buy-sell agreement values the business at $1,000,000.
- The agreement is a cross-purchase: at an owner's death, the survivor buys the deceased owner's interest.
- Each owner buys a $500,000 term policy on the other. Each owner is the owner, premium payor and beneficiary of the policy on the other's life.
- Neither policy has ever been transferred, and neither owner is an employer of the other.
Step 1: the interest to be bought. $1,000,000 × 50% = $500,000 for each owner's interest.
Step 2: the structure. A owns a $500,000 policy on B and pays its premiums; A is the beneficiary. B owns a $500,000 policy on A and pays its premiums; B is the beneficiary.
Step 3: B dies. The insurer pays A $500,000.
Step 4: the purchase. A pays B's estate $500,000 under the agreement. $500,000 received − $500,000 paid = $0 shortfall.
Step 5: income tax on the proceeds. On these assumptions, section 101(a)(1) generally excludes the $500,000 from A's gross income. The section 101(j) cap does not enter, because under Notice 2009-48, A-1, a contract owned by an owner to finance buying another owner's interest is not an employer-owned contract. The transfer-for-value rule does not enter, because no transfer occurred.
Step 6: premiums. The business pays nothing. Each owner pays premiums personally, and because each owner is the beneficiary of the policy he or she pays for, section 264(a)(1) would deny that owner a deduction even if one were otherwise available.
A variation. Suppose the owners later restructure into an entity purchase and transfer their policies to the business for value. Section 101(a)(2) would then limit the exclusion unless an exception applies. The section 101(a)(2)(B) list includes a partnership in which the insured is a partner and a corporation in which the insured is a shareholder or officer, so the answer depends on the entity form and the exact transfer. Once the business owns policies on its owner-employees, section 101(j) questions also arise. Whether either rule reaches a real restructuring depends on the facts of the contracts involved.
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Frequently Asked Questions
Can my LLC pay for life insurance on an owner or employee?
An LLC can pay premiums, but whether it can deduct them depends on who benefits from the policy. Section 264(a)(1) disallows the deduction when the payor is directly or indirectly a beneficiary. When an LLC pays premiums as compensation on a policy an employee owns, the analysis moves to section 162(a)(1) reasonableness. How a particular LLC is classified for these rules depends on its facts.
Can a business take out a life insurance policy on an employee?
A business can own a policy on an employee, but the contract is then generally an employer-owned contract under section 101(j). The exclusion for the death benefit is capped at the premiums and other amounts paid unless a section 101(j)(2) exception applies and written notice and consent were given before the contract was issued. Information reporting for these contracts also applies.
What is the transfer-for-value rule and why does it matter in business planning?
The transfer-for-value rule in section 101(a)(2) limits the death benefit exclusion for a policy transferred for valuable consideration to the consideration paid plus later premiums and other amounts. It matters because buy-sell restructurings often move policies between owners or into the business. Section 101(a)(2)(B) excepts transfers to the insured, to a partner of the insured, to a partnership in which the insured is a partner, and to a corporation in which the insured is a shareholder or officer.
What is employer-owned life insurance and what are the notice and consent requirements?
Employer-owned life insurance is, under section 101(j)(3), a contract owned by a person in a trade or business that is a beneficiary and that covers an employee on the date of issue. Section 101(j)(4) requires that, before issue, the employee be told in writing of the intent to insure and the maximum face amount, consent in writing (including to coverage continuing after employment ends), and be told in writing that the policyholder will be a beneficiary. Notice 2009-48, A-5, confirms that "employee" includes an officer, director and highly compensated employee.
What is a section 162 executive bonus plan?
"Section 162 plan" is industry shorthand for an executive bonus arrangement; it is not a qualified retirement plan, and section 162 does not create or define it. Section 162(a) is a deduction rule. In the usual design, the employer pays a policy's premium as extra compensation and the executive owns the policy and names the beneficiary. The employer's deduction is analyzed under section 162(a)(1), which allows a reasonable allowance for compensation, and the bonus is taxable income to the executive.
What is the difference between a cross-purchase and an entity-purchase buy-sell agreement?
In a cross-purchase, each owner owns a policy on the other owners and buys the deceased owner's interest; in an entity purchase, the business owns the policies and buys the interest. The choice affects how many policies are needed, whether the business is a beneficiary for section 264(a)(1) purposes, whether section 101(j) can apply, and how the transfer-for-value rule works if policies are later moved.
Does the SBA require life insurance for a business loan?
Only on the conditions set out in SBA SOP 50 10 8.1 (effective October 1, 2026). For a standard 7(a) loan, the lender may follow its internal policy for similarly sized commercial loans without an SBA guarantee, and the SBA's own life insurance condition applies where the loan is not fully secured and the principal is a sole proprietor, a single-member LLC owner, or the business depends on one owner's active participation. Whether a specific loan calls for coverage or a collateral assignment depends on the loan and the lender.
What is a section 412(e)(3) fully insured defined-benefit plan?
It is a defined-benefit plan funded exclusively by individual insurance contracts that meet each requirement of 26 U.S.C. § 412(e)(3)(A) through (F), including level annual premiums, insurer-backed benefits, no security interests and no policy loans. The IRS states that these plans were known as 412(i) plans before the Pension Protection Act of 2006. Contributions and benefits remain subject to the Code's plan limits.
What is split-dollar life insurance and which tax regime applies?
Split-dollar is an arrangement in which an employer and an employee share a policy's costs and benefits. Treasury regulations apply either an economic benefit regime or a loan regime, and which one governs depends on who owns the policy and how the arrangement is structured. "Equity" and "non-equity" are industry labels, not regulatory terms.
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