Life Insurance for Accounting Firms: Partner Buyouts and Succession

Short Answer: How Life Insurance Fits an Accounting Firm's Planning

Multi-partner accounting firms use life insurance mainly as a funding mechanism, not as a plan in itself. A policy can supply cash to buy a deceased partner's interest under a buy-sell agreement. It can also cushion the firm against losing a partner who holds key client relationships and support an orderly ownership transition.

This page addresses firms with two or more equity owners. It covers three business problems: a partner's death or departure, dependence on key people, and the transfer of ownership. A separate page of Business Life Insurance treats the solo or small CPA-owner practice.

Why Life Insurance Matters for Multi-Partner Accounting Firms

An accounting firm's value sits largely in things that cannot be sold off a shelf. Client relationships, goodwill and recurring engagement revenue make up most of it, and much of that value is tied to particular partners. In many firms a small number of partners originate or manage a large share of the client base.

Firms are commonly organized as general partnerships, limited liability partnerships (LLPs), professional corporations (PCs) or professional limited liability companies (PLLCs). The form matters for federal tax purposes. It affects who may own a policy without income-tax complications and how the death benefit is treated. State professional-licensing and ownership rules also apply to accounting firms, but they vary by state and are not addressed here.

A partnership or shareholder agreement often obliges the firm or the surviving owners to buy a deceased owner's interest. That obligation calls for liquid funds at an unpredictable time. Life insurance is one way to pre-fund it. What the interest is worth is a separate, fact-specific valuation question that the agreement and the firm's advisers settle.

Key Risks Accounting Firms Face Without a Funded Plan

Consider what happens when a buyout obligation exists but the cash does not. Surviving partners may owe a deceased partner's estate a price fixed by the buy-sell agreement, with no liquid source to pay it. They may pay from future earnings, borrow personally, or negotiate a discount with the estate. In the worst case, the firm may face a forced sale or a fire-sale price for the interest.

Revenue loss compounds the problem. When a rainmaker partner dies, fees that depended on that partner's relationships can fall quickly. Clients who worked with that partner may move to another firm. The firm's ability to service debt, meet payroll and fund the buyout can weaken at the same moment.

Continuity also depends on the documents. If the partnership or shareholder agreement does not address what happens at a partner's death, state partnership or corporate law may supply default rules, including dissolution provisions. Those rules vary by state.

These are business problems first. Life insurance is one funding tool among several, alongside cash reserves, installment notes and outside financing.

Who This Page Is For

The intended reader is an equity partner, managing partner, firm administrator or finance lead at an accounting firm with two or more equity owners. Readers in this position are usually weighing a buy-sell agreement, key-person coverage or a succession arrangement.

Several adjacent readers are served elsewhere. The solo CPA practice and the small owner-operated firm are covered on the site's CPA page. Shareholders of a PC or PLLC will find shareholder-specific rules on the site's shareholder life insurance page. Personal life insurance buying, association group programs and individual disability coverage fall outside this page's scope. Readers comparing how other professional firms handle partner buyouts may look at life insurance for law firms.

The page is educational. How any arrangement is structured, who owns the policies and how they are taxed depend on the firm's own facts.

Key-Person Considerations for Accounting Firms

Key person insurance for an accounting firm is a policy the firm owns on the life of a partner or employee whose loss would materially harm revenue or operations. The firm typically applies for the policy, pays the premiums and is named beneficiary. It may then use the proceeds to replace lost revenue, recruit a successor or fund a buyout.

The premiums are generally not deductible. Section 264(a)(1) of the Internal Revenue Code provides that "No deduction shall be allowed for... Premiums on any life insurance policy... if the taxpayer is directly or indirectly a beneficiary under the policy."

On the death benefit, section 101(a)(1) provides that "gross income does not include amounts received... under a life insurance contract, if such amounts are paid by reason of the death of the insured," subject to listed exceptions (see also 26 C.F.R. § 1.101-1). Two exceptions matter here: transfer for value under section 101(a)(2), and section 101(j) for employer-owned contracts.

Section 101(j)(1) caps the exclusion for an employer-owned contract at "the sum of the premiums and other amounts paid by the policyholder." The cap is lifted only when a section 101(j)(2) exception applies and the notice and consent requirements of section 101(j)(4) were met. The exceptions cover an insured who was an employee at any time during the 12-month period before death. They also cover an insured who was, when the contract was issued, a director, a highly compensated employee or a highly compensated individual as defined. A separate exception covers amounts paid to the insured's family, designated beneficiary, a trust for them or the estate, or amounts used "to purchase an equity (or capital or profits) interest" from such a person. Notice and consent must come "before the issuance of the contract," in writing. The employee must be told that the policyholder intends to insure the employee's life, the maximum face amount, and that the policyholder will be a beneficiary. The employee must also consent in writing, including to coverage continuing after employment ends. Notice and consent alone do not lift the cap, and neither does an exception alone.

IRS Notice 2009-48 addresses several of these points in question-and-answer form. A contract owned by an entity's owner "for purposes of financing the purchase of an equity interest of another owner" is not employer-owned (A-1). Ownership by a partnership "does not prevent the contract from being treated as an employer-owned life insurance contract" (A-3). "Employee" includes "an officer, director, and highly compensated employee" (A-5). The Notice also says written notice cannot be replaced by actual knowledge (A-7) and describes limited relief for inadvertent failures (A-13). Federal information reporting also applies to some employer-owned contracts.

Whether a particular firm policy is employer-owned, whether an exception and notice and consent apply, how the contract is reported and whether any premium is deductible all need individual review of the contracts involved by the insurers and a qualified tax professional.

Buy-Sell Considerations for Accounting Firm Partners

An accounting firm buy sell agreement is a contract among the partners, or between the partners and the firm, that governs what happens to a partner's interest at death, disability or departure. It sets the trigger, the price or pricing method, and the payment terms. Life insurance can fund the death trigger.

Two structures dominate. In a cross-purchase, each partner owns a policy on each other partner and buys the deceased partner's interest directly. In an entity purchase, called a redemption for a corporation, the firm owns a policy on each partner and buys the interest itself. A cross-purchase needs N × (N − 1) policies for N partners, which is a practical consideration rather than a tax rule. For a corporation using a redemption, the Supreme Court held in Connelly v. United States that the corporation's "contractual obligation to redeem" a deceased shareholder's shares "did not diminish the value of those shares" for federal estate tax. The decision addressed that one valuation question.

Transfer for value matters when policies change hands. Section 101(a)(2) limits the exclusion after a transfer "for a valuable consideration" to "the actual value of such consideration and the premiums and other amounts subsequently paid by the transferee." The regulation's Example 1 illustrates the limit: a buyer who paid $6,000 for a $100,000 policy may exclude only $6,000 plus later premiums (26 C.F.R. § 1.101-1(g)(1)). Section 101(a)(2)(B) excepts a transfer "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." A co-shareholder in a PC is not on that list. Whether an LLP or PLLC counts as a partnership for this exception turns on federal classification that is not addressed here.

Transfers of policies between partners or between a partner and the firm, and the valuation that sets the buyout price, need individual review of the contracts involved by the insurers and a qualified tax professional. More on owner-held policies appears on the page about life insurance for business partners.