Business loan protection involves the use of life insurance to create immediate working capital for a business to repay business debts in the event of the death of a business owner or other key executives.
In many small business situations, adequate financing is difficult to obtain. Creditors will often require that business owner(s) personally guarantee a loan. The untimely death of a business owner or another key executive may cause creditors to demand immediate repayment of outstanding business debts. This may place an unbearable burden on the business and force the liquidation of key business assets at fire sale prices at a time when business results may already be severely impacted by the death. In addition, if the business owner has personally guaranteed the debts incurred by the business, the business owner or the owner’s estate may be liable for any outstanding debts that the business cannot pay. In the absence of proper planning, the survival of the business may thus be affected by the death of the business owner or another key executive.
A solution is to purchase an insurance policy on the life of the business owner(s) or other key executives. Proceeds from the life insurance policy received as a consequence of the death of the life insured are tax-free and may be used to pay down the outstanding business debts.
A creditor may require the purchase of collateral life insurance to protect the interests of the creditor, particularly in small business situations in which the death of a business owner may impair the value of business assets used to secure the debt. In other cases, the business owner(s) may simply have a desire to have business debts fully repaid in the event of death to minimize financial risks for the heirs and to permit the continuation of the business free of debt.
Generally, life insurance premiums paid for business loan protection are not deductible for tax purposes. However, in the case of a life insurance policy that has been collaterally assigned to a restricted financial institution, a portion of the premiums may be deductible.
As noted earlier, in the case of a private corporation the receipt of a death benefit under a life insurance policy will result in a credit to the corporation’s capital dividend account. The credit to the capital dividend account is not affected by the fact that the insurance policy may have been collaterally assigned to a creditor.
A life insurance policy purchased for business loan protection can improve the ability of a business to negotiate loans, and provide for the repayment of business debts in the event of the death of a business owner or another key executive using tax-free life insurance proceeds. It can also prevent the business owner(s) or their estate from becoming personally liable for the business debts in the event of a death.