Key person insurance is an important consideration for business owner clients where they want to protect their business in the event of an unplanned exit, such as their death, disability or illness.
A common question we get asked is how should a client structure their key person insurance policy and what tax implications can be expected?
As a general rule, the trading entity (ie. The business) should own the key person policy. Remember that the purpose of a key person policy is to keep the business running so having the trading entity own the policy will allow the proceeds to flow directly to the entity that requires them.
The taxation implications of having the trading entity own a key person policy will depend on the business structure and the purpose of the key person policy, that is, whether the insurance is for a revenue or capital purpose.
Examples of revenue purpose items include replacing loss of revenue and operating expenses such as rent, advertising, utilities, replacement locum.
Conversely, a key person policy with a capital purpose will generally cover expenses such as debt repayment and replacing lost value which may occur from the loss of the key person, for example the cost of goodwill required to rebuild and maintain client relationships.
Although clients should refer to their tax adviser for specific information on their circumstances, the table below provides a summary of the tax treatment of key person cover where the owner is the trading entity: