If you own a business with a partner, answer one question: if your partner died tomorrow, who would own their half? For most North Carolina small business owners, the honest answer is “their spouse,” and the second honest answer is “I don’t have the cash to buy it from them.”
That’s the problem key person and buy-sell life insurance solve. They’re also two of the most commonly botched policies in small business, usually because of paperwork nobody told the owner about. Here’s what matters.
Key Person vs. Buy-Sell: Two Different Jobs
These get lumped together. They shouldn’t be.
Key person insurance
The business owns a policy on someone whose death would cost the business money: an owner, a lead estimator, the salesperson who brings in 40% of revenue. The business pays the premium and the business is the beneficiary. The payout covers lost revenue, recruiting a replacement, or reassuring a lender.
Buy-sell insurance
This funds a buy-sell agreement, a contract that says what happens to an owner’s share when they die. The life insurance puts cash in the right hands so the surviving owners can buy out the deceased owner’s family at a price already agreed on.
Without it, the surviving owner usually ends up in business with a spouse or kids who didn’t choose the business and may want out fast, at a number you’ll argue about.
The insurance is only half of it. A policy without a signed buy-sell agreement is just a death benefit. The agreement is drafted by an attorney; we size and place the insurance to fund it.
The Paperwork Trap: IRC Section 101(j)
This is where businesses get burned, and it’s pure paperwork.
Life insurance death benefits are normally income-tax-free. But under 26 U.S.C. § 101(j), when an employer owns a policy on an employee and is the beneficiary (an “employer-owned life insurance contract”), the tax-free amount is capped at the premiums paid, unless notice-and-consent requirements were met.
Before the policy is issued, the employee must:
- Be notified in writing that the employer intends to insure their life, including the maximum face amount;
- Give written consent to being insured, and to coverage continuing after they leave the company; and
- Be told in writing that the employer will be a beneficiary.
Miss that step and the cost can be large. For example, a $1 million key person policy that cost $30,000 in premiums could hand the business roughly $970,000 of taxable income at the worst possible moment. Fixing it afterward is narrow and not something to count on.
Even with consent in place, the tax-free treatment still has to fit an exception in the statute. For example, the insured was an employee within 12 months before death, was a director or highly compensated employee when the policy was issued, or the proceeds go to the insured’s family or are used to buy the insured’s ownership interest from them. Most owner-and-key-employee situations fit, but it has to be checked, not assumed.
Businesses with these policies also have to file IRS Form 8925 each year to report them. Ask your CPA whether yours is on the return.
Premiums Aren’t Deductible
Owners regularly ask about deducting key person premiums. Under 26 U.S.C. § 264(a)(1), no deduction is allowed for premiums on a life policy when the business is directly or indirectly a beneficiary. That’s the tradeoff for the death benefit generally coming in income-tax-free. Budget with after-tax dollars.
The Connelly Decision Changed How You Structure Buy-Sell Coverage
In June 2024, the U.S. Supreme Court decided Connelly v. United States. Two brothers owned a building supply company. The corporation owned $3.5 million of life insurance on each brother to fund a redemption (the company buying back a deceased brother’s shares).
When one brother died, his estate argued the company’s obligation to buy back the shares offset the insurance proceeds. The Court unanimously disagreed: the redemption obligation did not reduce the company’s value for federal estate tax. The insurance money inflated the company’s value, and the estate’s taxable value along with it.
What that means in practice:
- Entity-owned (redemption) plans can increase the value of the deceased owner’s estate.
- Cross-purchase plans, where the owners own policies on each other, generally avoid that specific problem, at the cost of more policies to manage as the number of owners grows.
- Other structures (trusteed cross-purchase, LLC-owned arrangements) exist. Which one fits is a question for your attorney and CPA, and the insurance should follow that decision, not lead it.
Does this matter in North Carolina?
North Carolina has had no state estate tax since it was repealed for deaths on or after January 1, 2013. The federal basic exclusion is $15,000,000 per person for 2026. So for many Triad businesses, Connelly won’t create an actual tax bill.
That doesn’t make it irrelevant. Estates cross that line faster than people expect once you add the business, real estate, retirement accounts, and personal life insurance. And valuation still matters for how your family and your partner split things. If your agreement was drafted before 2024 and uses company-owned policies, have it reviewed.
How Much Coverage?
Buy-sell
Start with what your ownership share is worth today, not what it was worth when you signed the agreement in 2015. The agreement should set a valuation method (fixed price updated annually, formula, or appraisal). A fixed price nobody has updated in six years is a common way these agreements fail.
Key person
There’s no statute here, just math. Common approaches:
- Cost to recruit, hire, and train a replacement, plus lost profit during the gap;
- A multiple of the person’s compensation; or
- The amount of business debt a lender would call or personal guarantees that would hit the family.
Term or permanent?
Term life is usually the right tool for key person coverage and for buy-sell plans with a defined exit horizon: cheaper, simpler, and it matches a temporary need. Permanent coverage can make sense when owners expect to hold the business until death or want the policy to support a lifetime buyout. Don’t let anyone sell you permanent coverage for a 10-year problem.
The Checklist
- Is there a signed buy-sell agreement? If not, start with your attorney.
- Does the agreement say who owns the policies, and does that match who actually owns them?
- Were 101(j) notice-and-consent forms signed before every employer-owned policy was issued?
- Is Form 8925 being filed?
- Has the valuation been updated in the last 12 to 24 months?
- Post-Connelly, has anyone looked at whether your structure still makes sense?
If you can’t answer yes to all six, your plan has a hole.
Talk to Safenet Insurance Group
We help Advance, Winston-Salem, and Triad business owners size and place key person and buy-sell coverage, work alongside your attorney and CPA, and make sure the policy paperwork matches the agreement. As an independent agency, we shop multiple life carriers instead of selling one company’s product.
Call Safenet Insurance Group at (336) 280-4606, or request a quote online.
This article is general information, not tax or legal advice. Talk to your CPA and attorney about your specific situation.
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