Biden’s Tax Plan May Trigger Key-Person Life Settlements

Kicking the can down the road may no longer be the wisest move for many retirement-age business owners who had planned to sell their companies in the next few years.

With President Biden’s tax proposal looming on the horizon, some tax advisors are urging their small business clients — many of whom hail from the baby boomer generation — to liquidate their businesses before year-end to avoid the higher capital gains tax bills. Some experts predict such tax changes could go into effect as early as January 2022 which explains why some business owners have already decided to get out while the getting is good.

According to tax attorney and blog writer Louis Vlahos of Rivkin Radler LLP, “The owners of many closely held businesses have already sold their business this year, while others are in the process of selling their business or are preparing for, or considering, such a sale before the end of the year.”

Life insurance professionals will want to take note of how this flurry of business selling activity may impact them.

Experienced agents who are knowledgeable about life settlement transactions possess valuable expertise relating to the disposition of key man or company-owned life insurance policies. Such policies were often purchased by the company’s founders to fund buy-sell agreements in the event of death. But once a business owner retires or sells the company, the need for such a policy becomes obsolete and the policy is often surrendered back to the carrier or allowed to lapse.

What many business advisors do not know is that such policies are considered an asset that can be monetized by selling it in the secondary market to institutional buyers. On average, the cash proceeds received by qualified policy owners is approximately four times the cash surrender value; however, some qualified sellers have received cash offers as high as 60% or more of the policy’s face value.

That’s why life insurance agents are well-positioned to play a critical role at the strategy table. Their unique expertise will be sought by the client’s other advisors as they work to unwind not only the client’s company but also the client’s key person life insurance coverage.

Considering the nexus involving the age of baby boomer business owners and the qualifying age (65 and above) for a life settlement, there is good reason to believe that Biden’s tax plan could very well increase the number of key person policies being sold in the secondary market.

Possible tidal wave of business selling activity

In a nutshell, Biden’s proposal eliminates the current rate on long-term capital gains for individuals with taxable income in excess of $1 million, which means it would go to the same level as the top ordinary income rate of 39.6% — nearly doubling the 23.8% top rate under current law. For aging business owners who have built successful companies valued far beyond the $1 million income threshold, their taxes from selling the business would likewise nearly double. As a result, the amount they were expecting to net from the sale of the business to fund their retirement is much lower.

Assuming the predictions hold true and numerous business owners do rush to salvage as much liquidity as possible from their businesses by selling before the end of this year, this could trigger an unprecedented demand for professional service providers such as business brokers, business valuators and appraisers, attorneys, accountants, and insurance professionals.

If only a small fraction of the 2.34 million businesses owned by baby boomers heed the call to sell now, it’s reasonable to assume that the domino effect will continue to generate revenue opportunities over the next few years for M&A professionals, insurance agents, and others who provide expertise in this niche.