A business can take out a life insurance policy on the person it can’t afford to lose: the founder who holds the customer relationships, the estimator who prices every job, the one driver with the hazmat endorsement and the contracts. The company owns the policy, pays for it and collects the death benefit, then uses the money to keep the doors open, hire and train a replacement, satisfy a lender or buy out the family’s share. The tax code calls it an employer-owned life insurance contract, and it comes with paperwork: the insured has to be told in writing and sign off before the policy is issued, and the business files Form 8925 with its return every year the policy is in force. Skip the paperwork and the death benefit above what the business paid in becomes taxable income.
What it is and who the parties are
IRMI defines key employee insurance as insurance that indemnifies a business for the loss of earnings from the death of a key officer or other employee: life and/or disability coverage on people whose loss may mean lost profit, lost goodwill or higher expenses, meant to finance the search and training of a successor or make up for reduced profits.
The business owns the policy, pays the premiums and is the beneficiary; the insured is the owner, officer or employee whose life is covered. The tax code calls this an employer-owned life insurance contract, and “employee” there includes officers, directors and highly compensated employees. A sole proprietor’s policy on his or her own life is not one; a wholly owned corporation’s policy on its owner-employee is, and that owner has to get the notice and sign the consent too.
What the money is for
The death benefit is cash the company controls:
- Continuity. Lost earnings while the company recruits and trains a replacement.
- Lender requirements. Under SBA’s SOP 50 10 8.1 (effective October 1, 2026), when a standard 7(a) loan is not fully secured, life insurance is required in the amount of the collateral shortfall for the principals of sole proprietorships, single-member LLCs and businesses otherwise dependent on one owner’s active participation. The lender takes a collateral assignment as assignee, and an existing policy can be pledged.
- Buy-sell funding. When the insured is a co-owner, the proceeds can buy that owner’s share from the family or estate, and the tax rules carve out amounts paid to them or used that way.
Notice, consent and Form 8925
Section 101(j) of the Internal Revenue Code caps the exclusion for an employer-owned contract at what the policyholder paid in unless an exception applies, and every exception requires three steps before the policy is issued:
- Written notice that the employer intends to insure the employee’s life, and of the maximum face amount, in dollars or as a multiple of salary, it reasonably expects to buy.
- Written notice that the employer will be a beneficiary of any proceeds payable at death.
- The employee’s written consent to being insured and to the coverage continuing after employment ends.
With that done, the exclusion survives if the insured was an employee at any time in the 12 months before death, was a director or highly compensated employee or individual when the contract was issued, or to the extent the money goes to the family, estate or equity buyout above. The consent only counts if the policy is issued within a year of signing and before the employee leaves, and a missed consent cannot be fixed after the insured has died.
Then the annual report: a policyholder with employer-owned contracts issued after August 17, 2006 attaches Form 8925 to its income tax return every year they are in force, listing employees at year end, how many are insured, insurance in force and whether it holds a valid consent for each.
Premiums and proceeds, in general
Two general rules I give every client, not tax advice. Premiums: section 264 of the tax code allows no deduction for premiums on a life insurance policy if the taxpayer is directly or indirectly a beneficiary under it, which describes key person coverage. Proceeds: death benefits are generally excluded from gross income under section 101(a), but for an employer-owned contract that holds only if the notice-and-consent steps were taken before issue and a section 101(j)(2) exception fits; otherwise the excluded amount is capped at what the business paid in and the rest is income. Have a CPA look at the setup before the policy is issued.
How the amount is set and what underwriters ask
The notice the employee signs has to state a maximum face amount, in dollars or as a multiple of salary, that the business reasonably expects to buy over the person’s tenure, so a multiple of pay is one accepted way to set it. The other way in is replacement cost: what it takes to find and train a successor, and the profit and goodwill that leave with the person. Insurable interest is state law and varies by state; New York, for example, recognizes an employer’s insurable interest in key persons whose death or disability would cause it a substantial pecuniary loss, with the criteria written into the insurer’s underwriting guidelines.
The person is underwritten like any individual life insurance applicant: depending on the policy, the insurer may ask health questions, require a doctor’s visit or send a medical professional to the office, and it checks the answers. Health can affect whether a policy is issued at all.
Not a buy-sell agreement, not group life
Key person insurance pays the business for losing the person; a buy-sell agreement answers a different question: who buys the departed owner’s share, and with what money. Policies the owners hold on each other to fund that purchase are not employer-owned contracts at all; when the company holds the policy and buys the interest from the family or estate, the section 101(j)(2)(B) exception keeps the proceeds excluded, provided the notice and consent were done before issue. D&O and a business owners policy cover other losses.
Group-term life is different again. Under section 79 the first $50,000 of employer-provided coverage is excluded from the employee’s income and the cost above that is imputed to the employee. It is the employee’s benefit, usually less than a family needs, it may not go with an employee who leaves, and New York, for example, as a rule bars an employer from receiving benefits under a group life policy.
Common questions
Does the business have to tell the employee?
Yes. Before the policy is issued the employee gets written notice of the intent to insure, the maximum face amount and the employer’s role as beneficiary, and signs a written consent. Without that, the income-tax exclusion is capped at what the business paid in, and even the sole owner-employee of a corporation has to sign.
Is Form 8925 filed every year?
Yes. A policyholder with employer-owned contracts issued after August 17, 2006 attaches Form 8925 to its income tax return for each year the contracts are in force, reporting employee counts, insurance in force and whether it holds valid consents.
Can the company deduct the premiums?
Generally no. Section 264 of the tax code allows no deduction for premiums on a life insurance policy when the taxpayer is directly or indirectly a beneficiary under it, and the business is the beneficiary here. Ask a CPA about your own situation.
What happens if the key person leaves?
The consent the employee signed covers coverage continuing after employment ends, so the business can keep the policy in force. The exclusion still applies if the insured was an employee at any time in the 12 months before death or was a director or highly compensated employee when the policy was issued; a later material increase in the death benefit is treated as a new contract and needs fresh notice and consent unless a valid consent is still in effect.
Can a key person policy satisfy an SBA loan?
Under SBA’s SOP 50 10 8.1 a lender may accept the pledge of an existing life insurance policy, with a collateral assignment naming the lender as assignee that the insurer’s home office acknowledges, and the borrower keeps paying the premiums. For a standard 7(a) loan that is not fully secured, the required amount is the collateral shortfall, and SBA says credit life or whole life should not be required.
Sources
- 26 U.S.C. §101 (Cornell LII): exclusion of life insurance proceeds and §101(j) employer-owned contracts
- IRS Notice 2009-48: treatment of certain employer-owned life insurance contracts (sections 101(j) and 6039I)
- IRS Form 8925 and instructions (Rev. September 2017): Report of Employer-Owned Life Insurance Contracts
- 26 U.S.C. §264 (Cornell LII): no deduction for life insurance premiums when the taxpayer is a beneficiary
- IRS: group-term life insurance and the section 79 exclusion
- IRMI: key employee insurance (definition)
- SBA SOP 50 10 8.1, Lender and Development Company Loan Programs (effective October 1, 2026): life insurance requirements
- NAIC Life Insurance Buyer’s Guide: applying for coverage and underwriting
- New York DFS OGC Opinion 05-10-17: employer insurable interest in key persons, Regulation 180, group policy benefits
General information about key person (employer-owned) life insurance as of October 2026, not legal or tax advice; IRC §101(j) and §264, IRS Notice 2009-48, the Form 8925 instructions and state insurance law control. Coverage depends on underwriting and the terms, conditions and exclusions of the policy actually issued.