Business Life Insurance for CPAs Who Own a Practice

Short Answer: What Business Life Insurance Does for a CPA Practice Owner

For a CPA who owns a practice, business life insurance is a way to fund obligations that arise when an owner dies. These include replacing lost revenue, buying out a co-owner's interest, paying off a practice loan, and paying for a planned succession. The insurance pays for the plan. It is not the plan itself.

This page covers the solo or small CPA practice. It looks at four uses: key person coverage, buy-sell agreement funding, succession funding and executive benefit arrangements. Multi-partner accounting firms are covered on a separate page of Business Life Insurance. Throughout, the federal tax result for any practice depends on how its policies are owned and structured.

Why Business Life Insurance Matters for a CPA Practice

Where an accounting practice's value rests largely on the owner, for example because clients stay for their relationship with a particular CPA, the owner is in economic terms the practice's key person.

The business problem comes first. An owner's death can lead to several things:

• Clients leave.
• Engagements already under way stall.
• A co-owner may end up holding an interest alongside the deceased owner's estate.
• A lender may call a loan.

Life insurance is one way to put cash where those obligations fall. State rules on who may own a CPA practice, or keep an interest after a death, vary by state.

One tax rule frames every entity-owned policy. Section 264(a)(1) of the Internal Revenue Code provides that "No deduction shall be allowed for" premiums on a life insurance policy "if the taxpayer is directly or indirectly a beneficiary under the policy or contract."

Key Risks a CPA Practice Owner Faces

The main risks are these:

• Loss of the owner-practitioner. Clients may leave, revenue may drop and open engagements may go unserviced.
• Ownership transition. If co-owners have no funded buy-sell agreement, a surviving CPA may find the deceased owner's heirs as business partners, or may face a buyout without the cash to pay for it.
• Debt exposure. A practice loan or line of credit may depend on the owner continuing to work. Lenders apply their own policies on life insurance. SBA lending rules call for it only in specific circumstances, such as certain loans that are not fully secured to a sole proprietor or single-member LLC owner. Those conditions are confirmed with the lender.
• Succession gap. If no successor has been identified and funded, much of the practice's value may never be realized.

State rules on who may hold a CPA practice interest vary.

Who This Page Is For

The reader here is a CPA who owns all or part of a small practice. That includes:

• a solo owner operating as a sole proprietorship or single-member LLC;
• a small practice with two to a handful of owner-practitioners;
• a professional corporation with one or a few shareholders, or a professional LLC;
• a partnership or multi-member LLC with other CPA owners.

Large multi-partner accounting firms raise governance and funding questions that this page does not address. Buying personal life insurance that has nothing to do with the practice is also outside this page. The broader context for owners of any business appears in life insurance for business owners.

Key Person Considerations for a CPA Practice

Key person insurance (sometimes called key person insurance for a CPA, or key man insurance for accountants) is a policy the practice owns on the life of someone whose death would cause it economic loss. The practice:

• owns the policy;
• pays the premiums;
• is the beneficiary.

The proceeds can cover lost revenue, the cost of hiring, or the cost of winding up engagements. How the owner, insured, beneficiary and payer roles fit together is set out in how business life insurance works.

Premiums. Because the practice is the beneficiary, section 264(a)(1) disallows a deduction for the premiums.

Death benefit. Section 101(a)(1) generally 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."

Employer-owned contracts. For an employer-owned life insurance contract, section 101(j)(1) caps the amount excluded from income at "the sum of the premiums and other amounts paid by the policyholder." The cap is lifted only if both of the following are true:

1. A section 101(j)(2) exception applies. One set of exceptions is based on the insured's status, for example an employee within the 12 months before death, a director, or a highly compensated employee or individual. The other covers amounts paid to the insured's heirs or used to buy an equity interest from them.
2. The notice and consent requirements were met "before the issuance of the contract." The employee must be told in writing of the intent to insure and the maximum face amount, must give written consent (including to coverage continuing after employment ends), and must be told in writing that the policyholder will be a beneficiary.

Notice and consent alone do not lift the cap. An exception alone does not lift it either.

IRS Notice 2009-48 addresses employer-owned life insurance contracts, including the following points:

• A-1. A contract owned by the owner of an entity, "such as for purposes of financing the purchase of an equity interest of another owner," is not an employer-owned contract.
• A-3. A policy "owned by a sole proprietor on his or her own life" is not one. However, ownership by a partnership or sole proprietorship does not by itself keep a contract from being one.
• A-5. "Employee" includes an officer, director and highly compensated employee.
• A-7. A wholly owned corporation and its employee-owner are not excused from the written notice and consent requirements.

Under section 6039I, a policyholder that owns employer-owned contracts files an annual return and keeps the related records.

Whether a particular practice policy is an employer-owned contract, whether an exception applies, and how section 264(a)(1) applies all need individual review of the contracts involved by the insurers and a qualified tax professional.

Buy-Sell Agreement Considerations for a CPA Practice

A buy-sell agreement is a contract among owners that sets what happens to an owner's interest at death or at another triggering event. A CPA buy-sell agreement can fix who buys the interest, at what price and on what terms. Life insurance is one way to pay that price.

The two main structures are:

• Entity purchase (redemption). The practice entity owns a policy on each owner, pays the premiums, receives the proceeds and buys back the deceased owner's interest.
• Cross-purchase. Each owner owns and pays for a policy on each other owner. At a death, the survivor collects the proceeds and buys the interest directly.

In either structure, the transfer-for-value rule can limit the section 101(a)(1) exclusion if a policy is later transferred. Under section 101(a)(2), when a policy is transferred "for a valuable consideration," the exclusion generally cannot exceed the actual value of that consideration plus the premiums and other amounts the transferee pays afterward.

That limit matters when a CPA practice buy-sell agreement is restructured and policies change hands. Section 101(a)(2)(A) excepts a transfer where the transferee's basis is determined in whole or in part by reference to the transferor's basis, and 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 professional corporation is not on the (B) list, although the corporation itself is. Whether an LLC or an LLP counts as a partnership for this exception is not stated in section 101(a)(2)(B).

State rules on who may hold a practice interest after a death vary. Ownership mechanics between co-owners are covered in life insurance for business partners.

Policy transfers between owners, and the valuation of the practice used to set coverage, need individual review by the insurers and a qualified tax professional, with qualified legal counsel.