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It can be difficult to obtain adequate debt financing for a small business. Creditors will often require the business owner to personally guarantee a loan. The death of the business owner or another key executive may cause creditors to demand immediate repayment of outstanding business debts. This can place a significant 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 owner or the owner’s estate may be liable for any outstanding debts that the business is unable to pay. If effective planning hasn’t taken place, the business may not survive the owner’s or another key executive’s death. A solution is for the business to purchase an insurance policy on the life of the business owner(s) or other key executives. Proceeds from the life insurance policy are taxfree and may be used to pay down the outstanding business debts. A creditor may require a small business to purchase collateral life insurance to protect the creditor’s interests, particularly if the death of the business’s owner could affect the value of business assets used to secure the debt. In other cases, the business owner may simply want to ensure that business debts will be fully repaid if he or she dies to minimize financial risks for heirs and to permit the business to continue free of debt. Generally, life insurance premiums paid for business loan protection are not deductible for tax purposes.
However, if a life insurance policy has been collaterally assigned to a restricted financial institution, a portion of the premiums may be deductible. A life insurance policy purchased for business loan protection can help a business negotiate loans and repay business debts with tax-free life insurance proceeds when a business owner or another key executive dies. It can also prevent business owners or their estate from becoming personally liable for the business debts if the owner dies.