What Is Key Man Life Insurance
Key man life insurance — also called key person insurance — is a life insurance policy owned by a business that insures the life of a person whose death would cause significant financial harm to the company. The business pays the premiums, the business is the beneficiary, and the business receives the death benefit when the insured person dies.
The “key person” can be an owner, a co-founder, a top salesperson, a lead engineer, or any individual whose skills, relationships, or knowledge the company could not easily replace. For most small Georgia businesses, the key person is the owner — the person who holds the client relationships, signs the contracts, and keeps the business running.
Key man insurance is not a substitute for a succession plan. It is a funding source for one. The insurance proceeds give the business or the surviving owners the cash to execute whatever plan is already in place — buying out shares, paying operating expenses during the transition, or repaying debt that was personally guaranteed by the deceased owner. Without a plan, the proceeds sit in the business with no legal direction on how to use them. See Business Succession Planning in Georgia for a full explanation of what a complete succession plan includes.
How Key Man Insurance Works With a Buy-Sell Agreement
The most common use of key man insurance in Georgia is to fund a buy-sell agreement. A buy-sell agreement is a contract that sets the rules for what happens to an owner’s shares when they die, become disabled, or leave the business. Without funding, a buy-sell agreement is a legal obligation with no money behind it.
There are two structures for how the insurance is owned and how the purchase works at death:
Entity-redemption structure. The company owns the policies on each owner’s life and is the beneficiary. When an owner dies, the company receives the death benefit and uses it to buy the deceased owner’s shares from the estate. The shares are then cancelled or redistributed. This is simpler to administer — one policy per owner — but creates the Connelly problem for C-Corps (explained below).
Cross-purchase structure. Each owner personally buys a policy on every other owner’s life and is the beneficiary. When an owner dies, the surviving owners receive the death benefit personally and use it to buy the deceased owner’s shares directly from the estate. This avoids the Connelly problem and gives surviving owners a stepped-up basis in the shares they purchase. The trade-off: with three or more owners, the number of policies multiplies quickly. An Insurance LLC can hold the policies on behalf of all owners as an administrative alternative. See Cross-Purchase vs. Entity Redemption Buy-Sell Agreement in Georgia for a full comparison of when each structure is correct.
The Tax Treatment of Key Man Life Insurance
Key man insurance has two relevant tax rules that every Georgia business owner should understand before buying a policy.
Premiums are not deductible. Under IRC § 264(a)(1), a business cannot deduct premiums paid on a life insurance policy when the business is directly or indirectly a beneficiary of that policy. This applies to key man insurance regardless of whether the business is a sole proprietorship, LLC, S-Corp, or C-Corp. The premiums are paid with after-tax dollars.
The death benefit is income-tax-free. Under IRC § 101(a), death benefits paid to a corporate or business beneficiary are excluded from federal income tax. The company receives the full death benefit with no income tax due — which is the reason key man insurance is so effective as a buy-sell funding mechanism.
EOLI consent is required. Under IRC § 101(j), an employer-owned life insurance policy only qualifies for the income-tax-free death benefit if the insured employee gave written consent before the policy was issued and received notice that the employer would be the beneficiary. A policy issued without this consent and notice will have its death benefit treated as ordinary income to the company. This is a paperwork requirement that is easy to satisfy — but it must be done correctly at policy inception.
The Connelly Warning — Key Man Insurance in a C-Corp
In Connelly v. United States (2024), the Supreme Court ruled that life insurance proceeds held by a C-Corp increase the fair market value of the company’s shares for estate tax purposes. The Court also held that the buy-sell redemption obligation does not offset that increased FMV. In the actual case, this produced $889,914 in additional estate tax on the deceased owner’s estate.
The mechanics: the company held $3.5 million in life insurance. When the owner died, those proceeds increased the company’s FMV by $3.5 million. The estate included shares valued at that higher FMV. The company then used the proceeds to redeem the shares — but the IRS and the Court treated the redemption obligation as a liability that did not reduce the estate tax valuation. The family paid estate tax on money that was simultaneously being used to buy back the shares.
C-Corp owners with entity-redemption buy-sell agreements funded by life insurance need to revisit their structure. The cross-purchase alternative avoids this problem because the insurance proceeds are paid to the surviving owners personally — not to the company — so they do not inflate the company’s FMV. Talk to your estate planning attorney and CPA together about your specific situation before making any changes.
This warning does not apply to S-Corps and LLCs in the same way — the Connelly ruling is specific to C-Corp entity-redemption structures where the company holds the insurance. See What Happens to a Georgia C-Corp When the Owner Dies for a full explanation of the Connelly ruling and its impact.
How Much Key Man Insurance Do You Need
The coverage amount depends on what the insurance is intended to do. There is no single formula, but three calculations are commonly used:
Buy-sell funding. The coverage should equal the agreed-upon value of the owner’s shares in the buy-sell agreement. If the agreement uses a formula or periodic appraisal to set value, the policy should be reviewed and updated whenever the business value changes significantly.
Revenue replacement. If the key person drives a significant portion of company revenue, the coverage should be large enough to sustain the business for 6 to 18 months while a replacement is found and trained — the typical time to replace a key person at a high-functioning level. A rule of thumb: 1 to 2 times annual revenue attributable to the key person.
Debt coverage. If the owner personally guaranteed business loans, the key man policy should be large enough to repay those loans at death. Without this, the lender can accelerate the debt against the estate or the surviving business immediately. See What Happens to Business Debt When the Owner Dies in Georgia for how personal guarantees work at death.
How to Set Up Key Man Life Insurance in Georgia
1
Determine what the insurance is funding
Before buying a policy, identify the specific purpose: buy-sell funding, revenue replacement, debt repayment, or all three. The purpose determines the coverage amount, the ownership structure, and which entity or person should be the beneficiary. A policy bought without a clear purpose often ends up with proceeds that have no legal direction for use.
2
Choose the right ownership structure — cross-purchase or entity-redemption
C-Corp owners should default to cross-purchase after Connelly unless a CPA has modeled both structures and confirmed entity-redemption is still preferable for their specific situation. S-Corp and LLC owners have more flexibility, but the cross-purchase structure’s basis step-up advantage is relevant for them as well. Document the choice and the reasoning in your buy-sell agreement.
3
Get the EOLI consent and notice forms signed before the policy is issued
Under IRC § 101(j), the insured employee must give written consent and receive notice that the employer will be the beneficiary before the policy is issued. This is a condition for the death benefit to be income-tax-free. Do not skip this step — the paperwork is simple, but it must happen at policy inception, not after.
4
Tie the insurance to a legally binding buy-sell agreement
The insurance policy and the buy-sell agreement must reference each other. The buy-sell agreement should specify that the insurance proceeds are the funding mechanism for the purchase, set the price or valuation formula, and identify who receives the proceeds and in what sequence. A properly drafted buy-sell agreement makes the insurance proceeds immediately usable — without it, the funds arrive without a legal framework.
5
Review the policy and buy-sell agreement together every three to five years
Business values change. Ownership percentages change. Tax law changes — as Connelly demonstrated in 2024. A key man policy bought five years ago may be underfunded, mis-structured, or legally misaligned with the current buy-sell agreement. Schedule a joint review with your estate planning attorney and CPA on the same cycle you use for your overall succession plan.
