Business Continuation Insurance: Keeping a Business Running After an Owner's Death

Who a Business Continuation Plan Is Typically For

Funded continuation plans may be considered in closely held businesses where one or a few people drive revenue, relationships or operations. These include S corporations, C corporations, partnerships, LLCs and professional practices.

• Businesses with two or more owners. These owners may want a mechanism to buy out a deceased owner's estate. The life insurance for business partners page covers partnership-specific rules.
• Sole proprietors and single-member LLC owners. Their businesses may not survive their death without a succession or wind-down plan.
• Borrowers. Businesses with loans whose terms call for life insurance on a principal are another group.
• Professional practices. Ownership and licensing rules for medical, dental, legal and accounting practices vary by state and by profession.

Owners looking at the full range of business uses can start with life insurance for business owners.

Where Life Insurance May Fit in a Continuation Plan

Life insurance fits in two places. Key-person coverage funds the operational gap. Buy-sell coverage funds the ownership transfer.

Key person. The business owns the policy, pays the premiums and is the beneficiary. The proceeds may cover the cost of replacing the owner's contribution or stabilize the business during the transition.

Buy-sell. In a cross-purchase, each owner owns a policy on each other owner. In an entity redemption, the business owns a policy on each owner. Either way, the proceeds supply the cash for the purchase obligation at death.

The death-benefit rule. Section 101(a)(1) 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." That exclusion has limits that matter in business planning. Transfer for value under section 101(a)(2) is one of them.

Employer-owned contracts. Section 101(j) is the other major limit. It applies to an employer-owned contract, meaning one owned by a person engaged in a trade or business that is directly or indirectly its beneficiary and that covers an employee on the date of issue. For such a contract, 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 does not apply only when both of two conditions are met:

1. An exception in section 101(j)(2) applies. The exceptions cover two situations: - The insured's status. The insured was an employee at any time during the 12-month period before death. Or, at the time the contract was issued, the insured was a director, a highly compensated employee or a highly compensated individual, as those terms are defined by cross-reference in section 101(j)(2)(A). - Amounts paid to heirs. The exception applies to the extent the amount is paid to a member of the insured's family, to an individual who is the insured's designated beneficiary under the contract (other than the policyholder), to a trust established for the benefit of either, or to the insured's estate. It also applies to the extent the amount is used to purchase an equity (or capital or profits) interest in the policyholder from such a person. 2. The section 101(j)(4) notice and consent requirements were met before the contract was issued. The employee must be notified in writing of the intent to insure and of the maximum face amount. The employee must give written consent, including consent that coverage may continue after employment ends. The employee must also be informed in writing that the policyholder will be a beneficiary.

Notice and consent alone do not lift the cap, and neither does an exception alone. IRS Notice 2009-48 (A-7) states that no exception excuses a wholly owned corporation and its employee-owner from these requirements. It also states (A-13) that failure to obtain written consent "cannot be corrected after the insured employee has died."

Premiums. Section 264(a)(1) provides that no deduction is allowed for premiums on a life insurance policy "if the taxpayer is directly or indirectly a beneficiary under the policy."

The tax treatment of business life insurance is covered on its own page.

When Life Insurance May Not Be the Answer

Insurability sets the first limit. If an owner cannot be insured, or coverage is not available at a workable cost, insurance cannot fund the plan. Installment notes, sinking funds or third-party financing may then carry the load.

Coverage can also fall short of value. If the business interest is worth more than the death benefit, the plan is underfunded, and the gap needs another source of cash.

A sole proprietorship has no co-owner to buy the owner's interest. In that case, insurance may fund an orderly wind-down or a transfer of assets rather than a continuing business.

A policy is not an agreement. If the buy-sell or continuation agreement was never drafted, or was not updated as the business changed, the policy alone does not create a continuation plan.

Cost is a planning factor in every case. Because section 264(a)(1) disallows a premium deduction when the taxpayer is directly or indirectly a beneficiary under the policy, owners may weigh the cost of the coverage against the business's cash flow.

Planning Options for Business Continuation

Several structures exist, and each works differently.

• Key-person life insurance. The business owns the policy, pays the premiums and is the beneficiary, and the proceeds stay in the business. The death benefit falls under section 101(a)(1), and it is subject to the section 101(j) cap if the policy is an employer-owned contract, unless a section 101(j)(2) exception applies and the notice and consent requirements were met.
• Cross-purchase buy-sell. Each owner owns a policy on each other owner. At a death, the survivors use the proceeds to buy the deceased owner's interest from the estate. Notice 2009-48 (A-1) states that a contract "owned by the owner of an entity" to finance buying another owner's interest is not an employer-owned contract.
• Entity-redemption buy-sell. The business owns a policy on each owner and uses the proceeds to redeem the deceased owner's interest. These policies may be employer-owned contracts under section 101(j) when the insured is an employee of the business. In Connelly v. United States (2024), the Supreme Court held that, in that case, the corporation's contractual obligation to redeem a deceased shareholder's shares "did not diminish the value of those shares" for federal estate-tax purposes. The opinion addresses that estate-tax valuation question on its facts, in which the corporation itself had received the insurance proceeds.
• Hybrid structures. Combinations of these structures also exist. The choice among them turns on the number of owners, the entity type and tax facts, including how each structure affects the survivors' basis in the purchased interest.

An executive bonus arrangement is a different strategy. "Section 162 plan" is industry shorthand for an executive bonus arrangement; it is not a special qualified retirement plan, and the Internal Revenue Code does not define the term. These arrangements are a compensation strategy rather than a continuation strategy, and Business Life Insurance covers them separately.

Whatever structure owners choose, the continuation agreement and the insurance funding work together, and the agreement needs to be kept current. The mechanics of funding a succession plan are explained in more detail on their own page.

Hypothetical Example: Two-Owner S Corporation

This example is hypothetical. Its figures are round and illustrative, and they are not a coverage recommendation.

Assumptions:

• Two equal owners, A and B, own an S corporation.
• The business is valued at $2,000,000, so each interest is worth $1,000,000.
• The owners have a signed cross-purchase agreement at that price.
• Each owner applied for, owns and pays for a $1,000,000 policy on the other owner, and each is the beneficiary of the policy he or she owns.
• No policy has been transferred, and neither policy is owned by the corporation.

Step 1. Owner A dies. Owner B receives $1,000,000 from the policy on A's life. Under section 101(a)(1), amounts paid by reason of the insured's death are generally excluded from gross income. Section 101(j) is not in play here, because, under Notice 2009-48 (A-1), a policy owned by an owner to finance the purchase of another owner's interest is not an employer-owned contract.

Step 2. Owner B pays the $1,000,000 to Owner A's estate under the agreement.

Step 3. The arithmetic of ownership works out as follows: B's original 50% plus the purchased 50% equals 100%. The estate holds $1,000,000 in cash in place of the shares.

Result. B's purchase price for the acquired shares is $1,000,000. How that price figures in B's tax basis, and the actual tax treatment of any real arrangement, depend on its specific facts.

Questions to Work Through Before Structuring a Plan

These questions frame the facts that typically decide the design:

• How many owners does the business have, and what role does each play in revenue and operations?
• Is there a current, signed buy-sell agreement? Does it name a funding mechanism and a valuation method?
• Are all owners insurable? How does the cost of coverage compare with the business's capacity to pay premiums that section 264(a)(1) may make nondeductible?
• Do any SBA or other loans carry terms calling for life insurance on a principal?
• Has the business's value been set by a method the owners and their advisers accept, and does the coverage amount align with it?
• For employer-owned policies, were the section 101(j) notice-and-consent steps completed in writing before issue, and is the reporting in order?
• Who should own each policy, who pays the premiums and who is the beneficiary under the chosen structure?

Liquidity for an estate that holds a business interest is covered under estate liquidity for business owners.