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Businesses often purchase life insurance on the lives of their owners, officers or key employees.
Understanding how an S corporation, a popular form of business incorporation, can use life insurance to protect itself is important if you are considering using this tool for your business.
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An S Corporation can have several owners, each of whom has an equal share of the business.
The ownership of the business is a personal asset to the owner, so if that person dies, their share of the ownership of the business passes to their heirs.
Unless the owner specifies in a will or a trust exactly who should inherit the business, it may be passed on to a person or people who have no ability to help run the business, or no interest in doing so.
In this case, it is common for the business to pay the heirs for the deceased owner’s share of the business.
But what if the company does not have enough money to do that? That’s where life insurance comes in.
An S corporation can take out a life insurance policy on each of the owners of the corporation, in an amount equal to the value of the owner’s share of the business.
Keep in mind that the value of the business may increase over time, so you should account for that when determining the correct amount of insurance to purchase.
The company can own the policies, pay the premiums and be the beneficiary of all of the policies. If the owner dies, the death benefit is paid to the corporation. The money can then be used to pay the owner’s heirs for the share of the company that the owner had.
The deceased owner’s share is then spread among the remaining owners.
For example, suppose there were five owners of an S corporation, each of whom had life insurance as described. One of the owners dies, and his life insurance policy pays the death benefit to the corporation.
The corporation pays the deceased owner’s heirs for 20 percent of the value of the company, since the deceased was one of five owners.
Each surviving owner now owns 25 percent of the company, and their heirs have been compensated for the value of the ownership share of the company that the deceased left to them.
Another way life insurance can be used by an S corporation is to insure the lives of key employees.
If your company has employees whose particular knowledge or expertise are critical to the success of the company, they may be difficult or time-consuming to replace if they should die prematurely.
Insuring the lives of these employees can help keep the company running if it takes a prolonged period of time to find a replacement.
When insuring the lives of key employees, the S corporation owns the policy, pays the premiums and is the beneficiary of the policy.
If the key employee dies, the policy pays the death benefit to the company.
The company can use the money to pay for a search for a new employee with the required skill set, or pay other costs that the company may incur due to the loss of the deceased key employee.
Determining the correct amount of insurance for a key employee policy can be tricky. It can be difficult to assign a dollar amount to the specialized knowledge or experience of someone who is a leader in their field.
Try to think about the costs the company would incur if the person were suddenly unable to do their job and contribute to the advancement of the company.
Insurance as a Benefit
Companies can also use life insurance as a benefit to employees. Some companies will pay for life insurance policies for their employees, and allow the employees to choose their own beneficiaries.
These group policies can sometimes be cheaper for employees to buy than an individual policy, because it is less expensive for the insurance company to insure a group of people than an individual.
Another appealing aspect is that these policies usually do not require a medical exam or history, so some employees who might not otherwise be able to purchase life insurance can still qualify.
In the case of life insurance as a benefit, the policy is usually owned by the company, and the company pays the premiums. The employee is the insured, and the beneficiaries are selected by the insured. The premiums that are paid are considered income to the employee, but the death benefit is paid out free of Federal income tax.
Some companies provide so-called ‘portable’ life insurance, which means that if an employee leaves the company, they can take their insurance policy with them. The employee would need to continue to pay the premiums on their own, but the insurance would continue uninterrupted as long as the premiums are paid.
According to the Internal Revenue Service, you can deduct the premiums for life insurance policies for the officers and employees only if you are not a beneficiary of the policy, either directly or indirectly.
If the purpose of the life insurance on the officers of the company is often to use the proceeds to buy out the heirs’ share of the company, and the proceeds are paid to the company, the company would benefit so the premiums would not be deductible.
If the insurance is a benefit of employment and the beneficiary is the spouse or children of the employee, it would be considered bonus compensation.
The premiums would be deductible for the company, but taxable to the officer or employee as income.
Taxation of life insurance policies held by or benefiting S corporations is complicated, so be sure to consult a qualified tax advisor to understand all the implications of your particular situation.
When purchasing life insurance on behalf of an S corporation, it is important to carefully compare the features and pricing of each policy to be sure that you are getting the appropriate policy for your needs.
The right insurance policies on owners, officers and employees can greatly contribute to the success of your business.
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