Life insurance in a business
Key person, buy-sell agreements, group life, and executive plans
The short version
Businesses buy life insurance for four jobs: to survive losing someone important, to fund the purchase of a dead owner's share, to give employees a benefit, and to pay executives later instead of now. The products are ordinary. What decides how these turn out is the tax law wrapped around them, and two rules cause most of the damage: a written notice a business has to give an employee before the policy is issued, and a 2024 Supreme Court decision that changed how a company's own insurance money is counted when an owner dies.
The four jobs
Before the details, here's the whole territory on one page.
| The job | What it's called | Who owns the policy |
|---|---|---|
| Survive losing someone the business depends on | Key person insurance | The business, which is also the beneficiary |
| Buy out a dead owner's share without selling the business | Buy-sell funding | Either the business, or the other owners individually. The choice matters enormously. |
| Give employees a benefit | Group term life | The employer carries the policy, covering the group |
| Pay an executive later instead of now | Deferred compensation and executive plans | Usually the business. Sometimes the executive. |
Key person insurance
Some businesses have one or two people the business runs on. The founder who holds the client relationships. The engineer who is the product. The salesperson who is half the revenue. Key person insurance, sometimes written "key man," is a policy the business owns on that person's life, with the business as the beneficiary. If they die, the money lands in the company rather than with the family, and it buys the company time to recruit, to reassure customers, and to cover the revenue that walked out the door.
The Insurance Information Institute describes the standard structure plainly: the policy is normally owned by the company, which pays the premiums and is the beneficiary.
You pay for it with after-tax money
The premium is not deductible. Section 264(a) of the Internal Revenue Code says no deduction is allowed for premiums on a life insurance policy "if the taxpayer is directly or indirectly a beneficiary under the policy or contract." Because the business collects, the business is the beneficiary, and the deduction is gone.
That's the trade. You pay with after-tax dollars, and in exchange the death benefit generally arrives free of income tax. Generally.
The notice rule that can tax the death benefit
When a business owns life insurance on an employee, tax law calls it an employer-owned life insurance contract. Section 101(j) says the amount the employer can exclude from income "shall not exceed an amount equal to the sum of the premiums and other amounts paid by the policyholder for the contract."
By default, the business gets back what it paid in premiums tax-free, and everything above that is taxable income. The death benefit on a key person policy is supposed to be many times the premiums paid. That difference is the whole value of the arrangement, and the default rule taxes it.
There is a way out, and it has to be done before the policy exists. Section 101(j)(4) requires three things in writing, before the contract is issued:
- The employee is notified in writing that the business intends to insure their life, and told the maximum face amount they could be insured for.
- The employee gives written consent to being insured, and consents that the coverage may continue after they leave the job.
- The employee is informed in writing that the business will be a beneficiary of any death proceeds.
Meeting those three isn't quite enough on its own. One of a list of exceptions also has to apply, and the usual ones do: the person was an employee within twelve months of death, or was a director or a highly compensated employee when the policy was issued, or the money goes to the family or is used to buy their share of the business.
Two details that decide real cases. The consent goes stale: it isn't valid unless the policy is issued within a year after the consent was signed, or before the employee leaves, whichever comes first. And this applies to contracts issued after August 17, 2006, with a warning attached, because a material increase in the death benefit or other material change causes the contract to be treated as a new one. A policy that was compliant can stop being compliant when someone raises the coverage.
There is no way to fix this afterward. You cannot get consent from someone who has died.
One more timing trap sits inside step two. A consent goes stale: it isn't valid unless the policy is issued within a year of the signature, or before the employee leaves, whichever comes first. A consent collected during a hiring process and used two years later has expired.
Here's what that costs, using round made-up numbers. A company holds a $2,000,000 policy on a key employee and has paid $60,000 of premiums over the years. The employee dies.
| Notice and consent signed before the policy was issued | Not signed | |
|---|---|---|
| Death benefit | $2,000,000 | $2,000,000 |
| Amount the business can exclude | $2,000,000 | $60,000 — the premiums it paid |
| Taxable income to the business | $0 | $1,940,000 |
One signature, obtained before the policy was issued, is the whole difference. And the business finds out which column it's in at the worst possible moment.
The Internal Revenue Service asks about it every year. Form 8925 must be filed by generally every policyholder owning employer-owned life insurance issued after that 2006 date, for each tax year the contract is owned. Line 4a asks whether a valid consent exists for each covered employee. Line 4b asks how many do not have one. The form is, in effect, asking a business to report its own exposure.
If your business owns a policy on anyone, this is the file to go pull.
Buy-sell agreements
A buy-sell agreement is a contract among the owners of a business that says what happens to someone's share when they die, leave, or become disabled. Without one, a deceased owner's share passes to their family, and the surviving owners find themselves in business with an heir who may want out, may want to run things, or may want to sell to a stranger.
Life insurance is the usual way to fund it, because it produces cash at exactly the moment the agreement requires cash. There are two ways to structure it, and the Supreme Court has now made the choice consequential.
| Cross-purchase | Entity purchase (redemption) | |
|---|---|---|
| The arrangement | The owners agree to buy each other's shares at death, and buy policies on each other to fund it. | The company is contractually required to repurchase a deceased shareholder's shares. |
| Who owns the policies | Each owner, on the other owners | The company, on each owner |
| Where the money goes | Directly to the surviving owner, who then buys the shares | Into the company, which then buys the shares |
| Number of policies | Grows quickly as owners are added | One per owner |
| Who pays the premiums | Each owner personally | The company |
Connelly v. United States, decided June 2024
Two brothers owned a building supply company. They had a redemption agreement, and the company held life insurance to fund it. One brother died. The company collected the insurance and used it to buy his shares from his estate. The estate valued his shares on the theory that the obligation to redeem cancelled out the insurance money.
The Supreme Court disagreed, unanimously. The holding, in the Court's words: a corporation's contractual obligation to redeem shares is "not necessarily a liability that reduces a corporation's value" for federal estate tax purposes.
The reasoning is worth reading, because it's simple. The Court said that "life-insurance proceeds payable to a corporation are an asset that increases the corporation's fair market value," and that "no willing buyer" purchasing the shares would have treated the redemption obligation as something that reduced their value.
What that means in practice: the insurance money the company collects to buy out the estate gets counted inside the company when the dead owner's shares are valued for estate tax. The shares are worth more than the owners expected, and the estate tax bill follows.
The Court knew the consequence and said so anyway. It acknowledged the company "would have needed an insurance policy worth far more" than the buyout price, and answered: "True enough, but that is simply a consequence of how the Connelly brothers chose to structure their agreement."
The Court also pointed at the alternative. Under a cross-purchase, the proceeds "would have gone directly to" the surviving brother rather than to the company. It noted cross-purchase has its own drawbacks, chiefly that each owner has to actually pay the premiums.
One limit, and it's in the Court's own footnote: it did not hold that a redemption obligation can never decrease a corporation's value. It rejected only the argument that all redemption obligations do.
Two things to keep straight. Connelly is an estate tax valuation case. It is not about income tax, and it is not about basis. And separately, the price written into a buy-sell agreement is not automatically the value the tax authorities accept. As the Court put it, such an agreement "is ordinarily not dispositive" for valuing the shares.
If your business has a redemption-style buy-sell funded by insurance and nobody has looked at it since mid-2024, that is a conversation to have.
A note on basis, and why we're sending you to an accountant
Basis is your investment in something for tax purposes. It's what gets subtracted from the sale price to work out your gain. Section 1012 sets the general rule: "The basis of property shall be the cost of such property."
Apply that to the two structures. In a cross-purchase, the surviving owner personally buys the departing owner's interest, so they have a cost in what they bought. In a redemption, the company buys the shares, and the surviving owner has not purchased anything, so no new cost arises for them.
Practitioners commonly conclude from this that cross-purchase gives survivors a step up in basis and redemption generally does not. The underlying rule is settled. The side-by-side conclusion is not something we found stated outright in any primary source, so we are giving you the mechanism and sending the conclusion to your accountant, where it belongs.
Group life insurance through work
The most common way people own life insurance is the way they think about it least. Your employer carries a policy over a group of employees, and you're covered as long as you work there.
For the coverage to get its tax treatment, it has to be a general death benefit, provided to a group of employees, in an amount set by a formula that prevents individual selection, using things like age, length of service, pay, or position. Generally there's a ten-full-time-employee rule, with exceptions. Coverage that includes a permanent benefit, meaning cash value, is not group term unless it meets separate conditions. In other words, group life is normally term.
The fifty-thousand-dollar line
You can receive up to $50,000 of employer-provided group term life coverage without it counting as income to you. Above that line, the cost of the extra coverage is added to your wages.
The amount added comes from a standard table the Internal Revenue Service publishes, not from what your employer actually paid. It uses your age at the end of the tax year, multiplied by the number of thousands of dollars of coverage above $50,000, reduced by anything you paid yourself. This is called imputed income: income you never received in cash but are taxed on anyway.
You can see it on your own W-2. It's included in boxes 1, 3 and 5, and reported separately in box 12 with code C. It's subject to Social Security and Medicare tax. We're deliberately not reprinting the rate table here, because it changes and a stale table would be worse than none. It's in the employer's tax guide, Publication 15-B, linked in the sources.
One exception if you own part of a small corporation: a shareholder owning more than 2% of an S corporation is not treated as an employee for this exclusion.
What happens when you leave
Group coverage generally ends with the job, and there's usually a right to convert it to an individual policy. How long you have to do that, and what notice you're owed, is set by your state's law and by the policy itself, and it varies. Don't rely on a number you read somewhere. Ask your employer for the certificate and find your own deadline. This is also why group coverage is a poor substitute for your own policy: it belongs to the job, not to you.
Deferred compensation and executive plans
The last category is the least understood, so it's worth being blunt about how it works.
Nonqualified deferred compensation
Nonqualified deferred compensation is an agreement to pay an executive later rather than now. Unlike a 401(k), it isn't a protected retirement account. The tax deferral exists precisely because the money isn't set aside for you.
The Internal Revenue Service says this plainly in its own audit guide. An unfunded arrangement is one where the employee has only the employer's "mere promise to pay," and the promise is "not secured in any way." The employer may invest in annuities, securities or insurance to help meet the promise, but only "as long [as] the annuities, securities, or insurance policies are owned by the employer and remain part of the employer's general assets."
This is where life insurance comes in. The company buys a policy, often on the executive's own life, to have an asset that grows alongside the obligation. The policy is a company asset. It is not yours.
So understand what you're holding. If the company becomes insolvent, you are an unsecured creditor standing in line with the suppliers. A rabbi trust, the common arrangement for holding these assets, does not change that: its assets must remain subject to the claims of the employer's creditors if the employer becomes insolvent.
That isn't a flaw somebody forgot to fix. It is the design. Security and tax deferral are opposites here, and you can't have both.
These plans are governed by Section 409A, which is unforgiving. The plan has to meet its requirements both in form and in operation. Deferral elections generally have to be made before the start of the year the money is earned. Payments generally can't be accelerated. Getting it wrong makes the deferred amounts taxable now, plus an additional 20% tax, plus interest, and the tax falls on the executive rather than the company that drafted the plan.
Executive bonus plans
A simpler arrangement, sometimes called a Section 162 bonus plan after the deduction it relies on. The executive owns the policy. The employer pays or bonuses the premium.
Because the employee owns it and the employer isn't a beneficiary, the Section 264 problem from the key person section doesn't arise, and the employer generally deducts the bonus as compensation. Section 162(a)(1) allows a deduction for "a reasonable allowance for salaries or other compensation for personal services actually rendered," so the deduction depends on total pay being reasonable. The bonus is taxable wages to the executive.
The appeal is that the executive genuinely owns the policy and takes it with them. The cost is that they pay tax on the bonus in the year they receive it.
Split-dollar arrangements
Split-dollar is an arrangement that shares the cost and the benefit of one policy between an employer and an employee. The regulation defines it as an arrangement "between an owner and a non-owner of a life insurance contract" meeting stated criteria.
There are two tax regimes, and which one applies is determined by the regulations rather than by what the parties call it. One treats the employer as providing an economic benefit to the employee. The other treats the arrangement as a series of loans. The difference drives the tax result for years, which is why these are drafted by specialists and reviewed when the tax rules move.
Corporate-owned life insurance
Corporate-owned life insurance is the general name for policies a company owns on its people, whether to informally fund deferred compensation or to cover a key person. Say it out loud so the connection is obvious: corporate-owned life insurance is employer-owned life insurance. The Section 101(j) notice and consent rules apply, and so does the Form 8925 filing. The same trap, in a different suit.
Where the risk actually sits
These arrangements aren't exotic. Closely held companies use them constantly, and often well. The Supreme Court's own description of that world is a fair one: closely held corporations "ordinarily have only a few shareholders (often within the same family)" whose shareholders "typically participate in the corporation's day-to-day management," which is exactly why they agree to restrict the transfer of shares to outsiders.
What goes wrong is rarely the product. It's the paperwork around it.
- Notice and consent that never happened. Written, before issue, no exceptions, no retroactive fix.
- An agreement and its funding that were never introduced. The buy-sell says one thing, the policies do another, and nobody reconciles them until somebody dies.
- A structure chosen before June 2024 and never revisited. Connelly changed the arithmetic on redemption-funded agreements.
- A valuation nobody tested. The price in the agreement is a starting point, not the answer.
- A deferred compensation promise mistaken for an account. It's a promise, and its safety is the company's safety.
Common questions
Can a business deduct the premiums on key person insurance?
Generally no. Section 264(a) of the Internal Revenue Code disallows a deduction for life insurance premiums where the taxpayer is directly or indirectly a beneficiary under the policy. Since the business is the beneficiary of a key person policy, the premiums are paid with after-tax dollars. The trade is that the death proceeds generally arrive free of income tax, provided the notice and consent requirements were met before the policy was issued.
What is the notice and consent requirement, and what happens if we missed it?
Before a business-owned policy on an employee is issued, the employee must be told in writing that the business intends to insure them and the maximum face amount, must consent in writing including to coverage continuing after employment ends, and must be told the business will be a beneficiary. If those steps were skipped, the business can generally exclude only what it paid in premiums, and the rest of the death benefit is taxable income to the business. There is no way to cure it after the fact, which is why this is worth checking now rather than later.
How did the Connelly decision change buy-sell agreements?
In Connelly v. United States, decided unanimously in June 2024, the Supreme Court held that a corporation's obligation to redeem a deceased shareholder's shares is not necessarily a liability reducing the corporation's value for estate tax purposes, and that life insurance proceeds payable to the corporation are an asset increasing its fair market value. In a redemption-style buy-sell, that means the insurance money is counted inside the company when the deceased owner's shares are valued. The Court noted that under a cross-purchase structure the proceeds would go directly to the surviving owner instead. It did not hold that every redemption obligation increases value.
Why is my employer-paid life insurance showing up as income on my W-2?
Employer-provided group term life coverage above $50,000 creates imputed income. The amount added to your wages is calculated from a standard table published by the Internal Revenue Service, using your age and the amount of coverage over $50,000, less anything you paid. It appears in boxes 1, 3 and 5 and separately in box 12 with code C, and it is subject to Social Security and Medicare tax.
Is money in a nonqualified deferred compensation plan safe if my employer fails?
No, and that is by design. The Internal Revenue Service describes an unfunded arrangement as one where the employee has only the employer's mere promise to pay, not secured in any way. Any insurance policy or investment the employer buys to back the promise remains the employer's general asset. A rabbi trust does not change this, because its assets must stay subject to the claims of the employer's creditors on insolvency. If the employer fails, you are an unsecured creditor. The lack of security is what allows the tax deferral.
What is the difference between an executive bonus plan and split-dollar?
In an executive bonus plan the employee owns the policy outright and the employer pays or bonuses the premium, which is taxable wages to the employee and generally deductible to the employer. In a split-dollar arrangement the cost and benefit of a single policy are shared between an owner and a non-owner of the contract, under one of two tax regimes set by regulation. The bonus plan is simpler and the employee keeps the policy; split-dollar is more complex and typically leaves the employer with a recoverable interest.
What is key person insurance, and is it worth it?
Key person insurance is a policy a business owns on someone the business depends on, with the business as the beneficiary. If that person dies, the money lands in the company, which buys time to recruit a replacement, reassure customers, and cover lost revenue. Whether it's worth it comes down to one question: would losing this person put the business at real financial risk? If the answer is yes, it can be valuable. The main drawbacks are that the premium is not deductible, and that the death benefit can become taxable if the written notice and consent steps were skipped before the policy was issued.
What are the types of buy-sell agreements, and who is the beneficiary?
There are two main structures. In a cross-purchase, each owner buys a policy on the other owners and is the beneficiary, so the money goes straight to the surviving owner, who then buys the deceased owner's share. In an entity purchase, also called a redemption, the business owns the policies and is the beneficiary, and the business buys back the share. The choice matters more since the Supreme Court's 2024 Connelly decision, which changed how the insurance money is counted when a redemption-funded company is valued for estate tax.
Can my LLC or business own a life insurance policy?
Yes. A business can own life insurance on an owner or an employee, and this is routine for key person coverage, buy-sell funding, and executive plans. Two rules come with it. When a business owns a policy on an employee, the written notice and consent steps have to be completed before the policy is issued, or part of the death benefit can become taxable. And the premiums are generally not deductible when the business is the beneficiary. Talk to an accountant before setting one up, because the ownership choice drives the tax result.
Is group term life insurance over $50,000 taxable?
The first $50,000 of employer-provided group term life coverage is tax-free to you. Above that line, you're taxed only on the cost of the extra coverage, not on the coverage amount itself, and that cost comes from a standard table the Internal Revenue Service publishes rather than from what your employer actually paid. The figure is added to your wages as imputed income and shows up on your W-2. So a large amount of employer coverage doesn't create a large tax, just a small one measured on the slice above $50,000.
Didn't find your situation? More to consider
Business arrangements sit alongside personal ones. If a business owns a policy on you, read who owns a policy and why it matters. If the goal is keeping proceeds out of an estate, start with trusts. And if the question is really about the coverage your own family needs, that's which type fits you.
Sources
- Internal Revenue Code §101, including §101(j) on employer-owned life insurance law.cornell.edu
- Internal Revenue Code §264: premiums not deductible where the taxpayer is a beneficiary law.cornell.edu
- Internal Revenue Code §162: deduction for reasonable compensation law.cornell.edu
- Internal Revenue Code §1012: cost basis law.cornell.edu
- IRS Form 8925, Report of Employer-Owned Life Insurance Contracts irs.gov
- IRS Notice 2009-48: questions and answers on §101(j) irs.gov
- Connelly v. United States, 602 U.S. 257 (June 6, 2024) supremecourt.gov
- IRS Publication 15-B: group term life insurance and the imputed income table irs.gov
- IRS Publication 5528: nonqualified deferred compensation audit technique guide irs.gov
- IRS Notice 2005-1: guidance on §409A irs.gov
- Treasury Regulation §1.61-22: split-dollar, economic benefit regime ecfr.gov
- Treasury Regulation §1.7872-15: split-dollar, loan regime ecfr.gov
- Insurance Information Institute: insuring the life of a key employee iii.org
Last updated: July 23, 2026