Month: April 2019

Can Your Business Survive the Loss of a Key Person? – Intrepid Law

You’ve likely protected your business with general liability coverage, property insurance, commercial automobile coverage, and workers’ compensation insurance. But for some businesses, operations would come to a grinding halt without certain essential contributors—key persons as we call them. If your business includes any key persons, key-person insurance should be a part of your business insurance planning.

What is a key person?

A key person is someone associated with the business that provides a significant, direct economic benefit. Economic benefit not only includes profits, but also considerations such as cost savings, goodwill, credit access, and customer access.

Business owners—particularly those of a small business—are often key persons. Some additional examples of key persons are:

  • A salesperson with well-established or numerous business contacts
  • An employee with specialized expertise
  • The inventor of the product
  • A programmer who wrote the foundational code
  • The owner with relationships that result in favorable credit terms

How does key-person insurance help?

Key person insurance compensates the business for any financial loss or cost incurred because the key person suffers an insurable event (death or extended disability).

1. Key person insurance provides financial security.

  • Key-person insurance can bridge the gap if the loss of the key person impacts the business’s revenue or affects the business’s creditworthiness.
  • If a buy-sell agreement is part of your business succession planning and the loss of the key person triggers a buy-sell event, key-person insurance (in the form of life insurance on each owner) funds the inside purchase of the deceased key person’s ownership interests, protecting both the remaining business owners and the deceased key person’s estate.

2. Key-person insurance buys your business time.

  • The cash injection key-person insurance provides can keep the business afloat while a replacement for the key person is recruited and trained.
  • If the key person is truly irreplaceable, key-person insurance can provide the funds that enable the business to pay its creditors, wind down the business operations, and dissolve.

Any other benefits to holding key-person insurance?

In addition to the peace of mind key-person insurance provides to business owners, the premium the business pays on key-person insurance may be deductible as a business expense. If proper notice and consent requirements are met, the proceeds from a key-person insurance payout may also be tax free. The tax implications of key-person insurance are complicated and specific to individual circumstances. It is crucial that you consult with your tax professional about this and other tax-planning strategies centered on key-person insurance before you purchase a policy or sign any documents.

Next steps

We work with businesses to evaluate business needs and goals to ensure that the overall business planning strategy is on target. If you are interested in learning more about key-person insurance and how it may fit into your business plan, please give us a call.

Making an S Corporation Election as a Married Business Owner

If you’re a married business owner and you want your business to be taxed as an S corporation, there are several things you need to know.

The difference between community property and co-ownership of an asset

Let’s take the example of owning a car. If you and your spouse are both on the title to a car, you co-own the car. This means both of you have the right to use the car, sell the car, or do anything you’d like with the car. It also means you are both responsible for paying off any debt or liabilities that arise from the car.  If one of you passes away, the survivor automatically becomes the sole owner of the car, without needing to take any additional actions.

But let’s say only one spouse has his or her name on the title. That spouse is the only owner of that car and is the only one (with certain exceptions) with rights and responsibilities attached to the car. When the owner spouse dies, the car would have to be transferred to the surviving spouse via the applicable estate plan or post-death or probate proceeding; it isn’t already owned by the other spouse like in the previous example.

However, ownership of the vehicle may look a little different depending upon your state of residence. In many states, such as California, there are rules that make most assets acquired during the marriage “community property” of the married couple. In this situation, each spouse has rights to the property, no matter whose name is on the title.  All assets that are considered community property are split up equally between the divorcing parties. In our car example, if the car is considered community property, it’ll be put into the big pot of community property and split evenly. That can result in either one party getting the car and the other spouse getting something of equal value to offset it, both parties splitting the ownership of the car, or the car being granted to both parties but one buys out the other’s share. The main point of community property is that the parties get an even split for assets acquired during the marriage.

Community property rules apply to all assets owned by either spouse, including ownership of a business. Spouses can co-own shares of a business, and, in fact, there may be legal and tax benefits for doing so. However, in the typical case of one spouse being involved with the business while the other is not, it usually does not make sense for the spouses to co-own the shares. Alternatively, if one spouse owns the shares individually, the other spouse may still have a community property interest, even if they’re not an owner.

How to fill out your Form 2553 S Corp Election

If your corporation or LLC decides to be taxed as an S corp, you must file a Form 2553 with the Internal Revenue Service (IRS). The tax code states that anyone with a community interest in the stock must consent to the tax election, and Form 2553 asks for a list of all owners. If the business owner’s spouse has a community property interest, it seems as though he or she must be listed on the form as well. However, he or she is not an owner, so they shouldn’t be listed as an owner, right? Be warned, if you list your spouse as an owner of the business when he or she is not, there could be serious consequences down the road. So how do you comply with the conflicting rules?

The answer is to list your spouse in the shareholder section, but note that he or she is not a shareholder. As you list all of the owners and their information, do include your spouse in the list, and do get his or her signature. However, unlike the actual owners, you will not list any ownership percentages or shares, or any dates those shares were acquired. Instead, you should note that the spouse is a “consenting spouse,” and you can also note that he or she owns 0% or zero shares of the business. This way, you are satisfying both requirements: you are getting affirmative consent to the tax election, but you are not claiming that they are an owner when they are not.

Special considerations for professional corporations

If you are forming a professional corporation, properly completing Form 2553 is especially important. The rules governing professional corporations vary from state to state, but generally, the rules will dictate that only members of that particular profession may be owners of the company. For example, if you’re starting a professional veterinary corporation, only licensed veterinarians can be owners of the business (or may have to own a majority of the business). If a non-professional is an owner, the status of the company can be put in jeopardy, and you could lose your entire business entity.

It is of the utmost importance that you comply with the ownership requirements in your state in order to be considered a professional corporation. If you incorrectly complete Form 2553, you’re putting your entire entity at risk. So professional corporations, be warned: If you are considering electing S corp status, make sure you consult with a professional. You are quite vulnerable if the form is filled out improperly. Problems are easier to prevent than solve!