Business Life Insurance for Physicians: Key Person, Buy-Sell and Practice Continuity

Short Answer: What Business Life Insurance Does for a Physician-Owner

For a physician who owns part or all of a practice, business life insurance is a way to fund obligations tied to that ownership: replacing value lost if the physician dies, paying for his or her share under a buy-sell agreement, and keeping the practice running through a succession. It is a funding tool, not personal family coverage.

This page addresses the physician as owner and insured: his or her share, the buyout of that share, and owner key-person cover. Planning for the practice entity as a whole, with several physicians, entity-owned policies and staff, belongs to the separate medical practices topic. Business Life Insurance explains United States federal tax rules here; state insurance rules vary by state.

Why This Matters Differently for Physicians

The federal rules that govern business life insurance turn on the legal form a practice uses, such as a corporation, a partnership or a sole proprietorship, so the same policy can be treated differently in two practices.

Where a practice's revenue depends on one physician's continued work, that physician-owner is both the practice's key person and the subject of any buyout.

State rules also shape the plan. Rules on the corporate practice of medicine and professional licensing vary by state. Personal life insurance bought for family income replacement is a consumer question outside this page. A general view of these uses for any owner appears under life insurance for business owners.

Key Business Risks a Physician-Owner Faces

The business problems come first; insurance is one possible way to fund a response to them.

• Key-person loss. Revenue and the patient base may depend heavily on one physician continuing to practice. A death can reduce collections while overhead continues.
• Unfunded buyout. Without a funded agreement, a surviving physician may end up sharing ownership with a deceased colleague's estate or heirs, or may lack cash to buy the interest.
• Practice debt. Equipment, real estate or practice-acquisition loans may still need payments after an owner's death. Lender requirements, including any collateral assignment of a policy, vary by lender.
• Succession gap. A solo physician's practice may have no arrangement for transferring goodwill or patient relationships to a successor.
• State ownership rules. Corporate-practice-of-medicine and licensing rules vary by state and are a separate question from the federal tax rules discussed here.

Who This Page Is For

The reader here is a physician with an ownership stake: a solo practitioner, one of two physician partners, a shareholder in a professional corporation, or a member of a professional LLC. It also fits a physician weighing how to fund a physician buy-sell agreement tied to his or her interest, or one whose practice carries business debt.

It is not written for physicians seeking personal coverage for family income, for employed physicians with no equity stake, or for multi-physician groups evaluating entity-level or staff coverage. Outcomes under the federal rules depend on the practice's structure and the facts of each contract.

Key Person Considerations for Physicians

Key person insurance for physicians, sometimes called key man insurance for doctors, is a policy owned by the practice on the life of a physician whose loss would materially harm revenue or operations. These are industry terms, not terms defined in the Internal Revenue Code. Typically the practice owns the policy, pays the premiums and is the beneficiary; the physician-owner is the insured; proceeds go to the practice to absorb lost revenue, recruit a replacement or meet obligations. The mechanics are covered more generally under how business life insurance works.

Section 264(a)(1) of the Internal Revenue Code provides that "No deduction shall be allowed for— (1) Premiums on any life insurance policy ... if the taxpayer is directly or indirectly a beneficiary under the policy or contract." A practice that is the beneficiary therefore generally cannot deduct the premiums.

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 exceptions including transfer for value (section 101(a)(2)) and section 101(j). For an employer-owned contract, section 101(j)(1) caps the exclusion at "the sum of the premiums and other amounts paid by the policyholder for the contract." The cap is lifted only when a section 101(j)(2) exception applies, one based on the insured's status or one for amounts paid to the insured's heirs, and the written notice and consent requirements of section 101(j)(4) were met "before the issuance of the contract." Notice and consent alone do not lift the cap, and neither does an exception alone.

The practice's form matters. Notice 2009-48 A-5 confirms that "employee" includes "an officer, director, and highly compensated employee," which can reach a physician who is an officer, director or highly compensated employee of the practice. A-3 states that "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 that a contract "owned by a sole proprietor on his or her own life is not." A-7 states there is no exception excusing "a wholly-owned corporation and its employee-owner" from the written notice and consent requirements, which bears on a single-physician professional corporation. A-13 describes limited relief for inadvertent failures, and states that a missing written consent "cannot be corrected after the insured employee has died." Section 6039I also requires each applicable policyholder owning employer-owned contracts to file an annual return and keep records showing whether section 101(j) is met.

Employer-owned life insurance notice and consent, and the related reporting, need individual review of the contracts involved by the insurers and a qualified tax professional.

Buy-Sell Considerations for Physician-Owners

A buy-sell agreement for doctors is a contract among physician co-owners, or between an owner and the practice, that obligates the survivors or the practice to buy a deceased physician's interest at an agreed or formula price. Life insurance can supply the cash at death.

Two structures are common. In a cross-purchase, each physician owns, pays for and is beneficiary of a policy on the other, and uses the proceeds to buy the interest from the estate. In an entity purchase, or redemption, the practice owns policies on each owner and buys the interest itself. Notice 2009-48 A-1 states that a contract owned by an owner of an entity "for purposes of financing the purchase of an equity interest of another owner" is not an employer-owned contract.

Transfer for value matters when policies change hands, for example when a practice moves policies to the owners. Section 101(a)(2) limits the exclusion after a transfer for valuable consideration to "the actual value of such consideration and the premiums and other amounts subsequently paid by the transferee." 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." In a professional corporation, a co-shareholder is not on that list, though the corporation is. Whether an LLP or LLC counts as a partnership for these rules is a question the statute's text does not answer, and it needs professional analysis. More on owner-to-owner arrangements appears under life insurance for business partners.

The funding amount may be set by reference to the value of the interest, and valuation methods differ; both valuation and policy transfers are fact-specific matters for the practice's tax and legal advisers. State rules on who may hold the interest vary by state.