# Key Person Insurance for California Small Businesses > Key person insurance for California businesses: IRC 101(j) notice and consent, Insurance Code written consent, tax treatment, Form 8925, and sizing coverage. Source: https://ridleylawoffices.com/key-person-insurance-california/ **Short answer:** Key person insurance is a life or disability policy a business owns on an owner or employee whose loss would cost the business money. The business pays the premiums and collects the benefit. The premiums aren’t deductible, and the death benefit is fully tax-free only if the insured got written notice and consented in writing before the policy was issued. California adds its own written-consent rule. - No deduction is allowed for premiums on a life insurance policy if the taxpayer is directly or indirectly a beneficiary (IRC § 264(a)(1)). - For an employer-owned policy, the tax-free amount is capped at the premiums paid unless the notice-and-consent rules are met and an exception applies (IRC § 101(j)). - California applies the same federal rule to employer-owned policies held by corporations (Rev. & Tax. Code § 24305(c)). - A California employer has an insurable interest in its directors, officers, and employees, and must obtain the written consent of the person insured (Ins. Code § 10110.1(c)). Small businesses usually depend on one or two people more than they admit. Key person insurance puts a number on that dependence and gives the company cash to survive the loss. I’m not an insurance agent and I don’t recommend carriers or products. I draft the consents, resolutions, and agreements that decide whether the policy does what the owners think it does, and this page covers the California and federal rules that go with it. ## Who counts as a key person? It’s insurance the business buys to protect itself, rather than the insured person’s family. A key person is anyone whose death or disability would cut revenue, scare off a lender, or stall the business while a replacement is found. - A founder who holds the client relationships. - The one licensed professional a firm can’t operate without. - A salesperson who brings in a large share of revenue. - An engineer or technician with knowledge nobody else has. - An owner who personally guarantees the company’s loans. The business is the owner of the policy, pays the premiums, and is named as beneficiary. The insured person has no claim on the proceeds. That’s what separates key person coverage from a policy the owner buys for a spouse and children, which I cover in my guide to [life insurance in an estate plan](https://ridleylawoffices.com/life-insurance-estate-planning/). ## Can a California business insure an employee’s life? Yes, if the business has an insurable interest and the person consents in writing. California defines an insurable interest for life and disability insurance as one based on a reasonable expectation of financial advantage from the other person’s continued life or health, and a consequent loss from that person’s death or disability ([Ins. Code § 10110.1(a)](https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=INS§ionNum=10110.1)). An employer has an insurable interest in the life of any of its directors, officers, or employees, and of any other person whose death or disability might cause financial loss to the employer (Ins. Code § 10110.1(c)). The same subdivision gives an employer an insurable interest in a shareholder’s life under a contract to reacquire that shareholder’s shares at death or disability, which is the redemption buy-sell arrangement. It ends with a flat requirement: the employer shall obtain the written consent of the individual being insured (Ins. Code § 10110.1(c)). The Insurance Code also sets the timing. An insurable interest must exist when the contract becomes effective, but need not exist when the loss occurs (Ins. Code § 10110.1(f)). A policy procured on another person is void unless the applicant has an insurable interest in that person at the time of the application (Ins. Code § 10110.1(g)). So a company can keep a policy on an employee who later leaves, as long as the interest existed when the policy was issued. ## Is key person insurance tax-deductible? No. Federal law disallows a deduction for premiums on any life insurance policy if the taxpayer is directly or indirectly a beneficiary under the policy (IRC § 264(a)(1)). The company pays the premiums with after-tax dollars, whether it’s a C corporation, an S corporation, or an LLC. Your CPA will tell you how the nondeductible premium flows through to the owners of a pass-through entity. ## Are key person insurance proceeds taxable? Usually not, if the paperwork was done before the policy issued. Life insurance paid by reason of the insured’s death is generally excluded from gross income (IRC § 101(a)(1)). An employer-owned life insurance contract is an exception to that rule. For an employer-owned contract, the amount excluded from the policyholder’s income can’t exceed the premiums and other amounts it paid (IRC § 101(j)(1)). On a $1,000,000 policy that cost $40,000 in premiums, only $40,000 would be excluded, leaving about $960,000 as taxable income in the year of death. The full exclusion returns only when the notice and consent requirements are met and one of the statutory exceptions applies (IRC § 101(j)(2)). ### The notice and consent requirements Before the policy is issued, the insured employee must be notified in writing that the policyholder intends to insure the employee’s life and of the maximum face amount at issue (IRC § 101(j)(4)(A)). The employee must give written consent to being insured and to coverage continuing after the employee leaves (IRC § 101(j)(4)(B)). The employee must also be told in writing that the policyholder will be a beneficiary of the death proceeds (IRC § 101(j)(4)(C)). I prepare one form that does all three, signed and dated before the application is submitted, and I keep the insurer’s issue date next to it in the file. A consent signed after issue doesn’t count. ### The exceptions Once notice and consent are in place, the full exclusion applies if the insured was an employee at any time during the 12 months before death (IRC § 101(j)(2)(A)(i)). It also applies if, when the policy was issued, the insured was a director or a highly compensated employee (IRC § 101(j)(2)(A)(ii)). A third exception covers proceeds paid to the insured’s family, estate, or a trust for them, or used to buy an equity interest in the business from them (IRC § 101(j)(2)(B)). A working owner or senior employee usually fits the first two, so the usual failure is a missing consent. ### Annual reporting A business that owns employer-owned policies must file a return each year showing the number of its employees, the number insured, the total insurance in force, and whether it holds a valid consent for each insured employee (IRC § 6039I(a)). The IRS form is Form 8925. The same section requires the business to keep the records needed to show it met the rules (IRC § 6039I(b)). Replacing a policy can restart the clock. Under the 2006 effective-date rules, an exchange or any material increase in the death benefit or other material change can cause the contract to be treated as new (IRC § 101 note). Get a fresh notice and consent whenever the coverage changes. ## Does California tax key person insurance proceeds? California follows the federal rule. For corporations, an amount received by reason of the death of an insured under an employer-owned life insurance contract is excluded from gross income only in accordance with the federal rule for those contracts ([Rev. & Tax. Code § 24305(c)](https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=RTC§ionNum=24305)). For individual owners of pass-through entities, California’s personal income tax adopts the federal exclusions from gross income, except as otherwise provided ([Rev. & Tax. Code § 17131](https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=RTC§ionNum=17131)). In practice, one set of consent forms satisfies the federal rule, California’s income tax rule, and the Insurance Code’s written-consent requirement. Missing them can cost the business on both returns. ## How much key person insurance does a business need? Enough to cover what the business would lose while it recovers, plus any debt the insured person guaranteed. There’s no statutory formula. Agents often quote a multiple of salary, which is a starting point at best. I’d build the number from three pieces. 1. **Lost profit during the gap.** The gross profit the person generates, times the months it would take a replacement to produce at the same level. 2. **Replacement cost.** Recruiting, signing bonus, training, and a period of overlapping pay. 3. **Debt and guarantees.** Loans the person guaranteed, which a lender may call or demand be replaced. Take a worked example. A Santa Barbara software consulting firm has a lead engineer who generates $600,000 a year in gross profit. The owners estimate twelve months to recruit and ramp up a replacement, during which the firm loses about half of that profit, $300,000. Recruiting and overlap pay add $80,000, and the engineer guarantees nothing. A policy of about $400,000 covers the gap. If the engineer is also an owner, the buyout price is a separate number, and a [buy-sell agreement](https://ridleylawoffices.com/buy-sell-agreement-california/) should say whether the same policy funds both. ## What about disability? A key person is more likely to become disabled for months than to die during working years, and many businesses insure only death. Key person disability coverage pays the company a benefit after a waiting period. A separate buyout disability policy pays a lump sum to fund the purchase of a disabled owner’s interest. The definition of disability in the policy should match the one in the buy-sell or operating agreement, or the policy may pay while the agreement’s buyout never triggers. ## Key person insurance or buy-sell insurance? Same kind of policy, different job. Key person insurance replaces lost value for the company. Buy-sell insurance funds the purchase of a departed owner’s interest. One policy can do both, but only if the documents say how the proceeds are split between recovery and the buyout. If a corporation owns the policy and uses the proceeds to redeem a deceased owner’s shares, the proceeds count as a company asset for federal estate tax. The Supreme Court held in *Connelly v. United States* (2024) that a corporation’s obligation to redeem shares at fair market value doesn’t offset insurance proceeds earmarked for the redemption. My [buy-sell guide](https://ridleylawoffices.com/buy-sell-agreement-california/) covers when that matters and how a cross-purchase avoids it. ## What happens to the policy when the key person leaves? The company still owns it. Because the insurable interest only has to exist when the policy takes effect, the company can keep paying and keep the benefit. The federal consent form covers this too, since the employee consents to coverage continuing after employment ends. Many companies sell or transfer the policy to the departing person instead. A sale can trigger the transfer-for-value rule, which caps the tax-free benefit, although the rule doesn’t apply to a transfer to the insured person (IRC § 101(a)(2)). A sale to the insured is usually the clean exit. Your CPA should value the policy before any transfer. ## How do I set up key person insurance correctly? 1. Decide who’s key and how much each loss would cost. 2. Adopt a written resolution by the board or the members authorizing the purchase, naming the company as owner and beneficiary. 3. Have each insured person sign the combined federal notice-and-consent and California written consent before the application goes in. 4. Keep the signed forms, the application, and the issue date together in the company records. 5. File the annual report on Form 8925 for each year the company owns the policy (IRC § 6039I). 6. Review coverage each year and get new consents before any increase or replacement. 7. Coordinate the policy with the buy-sell agreement and each owner’s estate plan. ## How does this fit my estate plan? If you’re the key person, the proceeds go to your company, not to your family. They may raise the value of your ownership interest, but your family sees that value only through a buyout or a distribution. Your personal coverage for your spouse and children should be separate, often held in an [irrevocable life insurance trust](https://ridleylawoffices.com/do-i-need-an-irrevocable-life-insurance-trust-in-my-estate-plan/) when estate tax is a concern. The rest of the owner’s plan is in my [business succession planning](https://ridleylawoffices.com/business-succession-planning-california/) guide and the [business continuity guide](https://ridleylawoffices.com/guides/business-continuity/). ## Where I fit I draft the notice-and-consent forms, the authorizing resolutions, and the buy-sell or operating agreement provisions that decide how proceeds are used. I don’t sell insurance, recommend a carrier or product, or set coverage amounts, which belong with a licensed agent and your CPA. If a claim is denied or a dispute over proceeds turns into a lawsuit, you need litigation counsel, and I can refer you. ## Frequently asked questions ### Who owns a key person insurance policy? The business. It applies for the policy, pays the premiums, and is the beneficiary. The insured person consents in writing but has no right to the proceeds. ### Can I deduct key person life insurance premiums? No. Federal law disallows the deduction when the business is a beneficiary of the policy, and a key person policy always names the business. California follows the federal treatment. ### Do I need the employee’s permission to buy key person insurance? Yes. California’s Insurance Code requires the employer to get the insured person’s written consent, and the federal tax exclusion requires written notice and consent before the policy is issued. The insurer’s application will also require the insured’s signature and usually a medical exam. ### What happens if we forgot the 101(j) consent? For a policy already issued, it can’t be fixed after the fact. The business can apply for a new policy with proper notice and consent in place, then decide whether to keep or surrender the old one. Talk to your CPA and agent before dropping any coverage. ### Is key person insurance required for an SBA or bank loan? Some lenders require life insurance on the owners or key managers as a loan condition. The lender’s commitment letter controls. If the lender will be an assignee or beneficiary, the consent forms and resolution should say so. ### Does an LLC need key person insurance? Any business that would lose money if one person died or became disabled should consider it. For a multi-member LLC, the bigger question is usually buyout funding, which is part of the operating agreement or a separate buy-sell agreement. More in this series - [Buy-sell agreements for California businesses](https://ridleylawoffices.com/buy-sell-agreement-california/) - [Partnership agreements in California](https://ridleylawoffices.com/partnership-agreement-california/) - [Business divorce and partner buyouts](https://ridleylawoffices.com/business-divorce-partner-buyout-california/) - [Removing a member from an LLC](https://ridleylawoffices.com/how-to-remove-member-from-llc-california/) - [Adding a member to an LLC](https://ridleylawoffices.com/how-to-add-member-to-llc-california/) - [All business owner guides](https://ridleylawoffices.com/business-guides/) I draft key person consents, authorizing resolutions, and buy-sell provisions at $500 per hour. My rates are on the [fees page](https://ridleylawoffices.com/fees/), and the rest of my business work is on the [business law attorney](https://ridleylawoffices.com/business-law-attorney/) page. [Talk to Eric](https://ridley.click/eric-60) Book a consultation at [ridley.click/eric-60](https://ridley.click/eric-60) or call 805-244-5291. I work with business owners in Ventura, Santa Barbara, and Los Angeles counties by Zoom or phone. **Please read:** This page is general information about California law as of September 2026. It isn’t legal, tax, or financial advice, and reading it doesn’t make you my client. Tax treatment and the right amount of coverage depend on facts this page can’t see, so talk with your CPA and a licensed insurance agent as well. An attorney-client relationship starts only with a signed engagement agreement.