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.

According to merger and acquisitions firm Symmetrical M&A Advisory Inc., the Biden tax proposal will especially impact the lower middle market of business owners with revenues between $5 million and $100 million. This tier of business owners is comprised of 350,000 small companies, most of which are owned by aging baby boomers at or near retirement. The firm's website states, "We expect the Biden tax plan could add another layer of urgency over the next year as [baby boomer] business owners rush to sell before the Biden plan is implemented."

Preparation Is Key

Insurance professionals have a unique opportunity to benefit from the economic climate described above and to occupy a seat at the strategy table for business clients looking to sell quickly.

The key is preparation.

First, take some time to refresh your knowledge of the secondary market for life insurance and review case examples and success stories — especially life settlement transactions involving key man policies.

Next, go through your client files and identify any life insurance policies owned by aging business executives who may be thinking of retiring in the near future. Ask them whether they are planning to sell their business before the end of the year. If so, share your insight about the Biden tax proposal and educate them about the life settlement option for key man policies.

Contact other professionals in your referral network (e.g. property and casualty agents, business valuators, appraisers, business brokers, CPAs, attorneys, etc.) and offer to provide your expertise regarding the liquidation of key person life insurance policies. Explain how the cash proceeds from selling an obsolete policy could be used to help fund the business owner's retirement, or help to offset the tax burden incurred from the sale of the business.

Take Aways

The current economic and political climate presents what may turn out to be an unprecedented opportunity for insurance professionals whose clients include small business owners looking to retire.

As noted by Small Business Deal Advisors, "The M&A market in 2021 looks strong. Interest rates are low, private equity demand is high, strategic acquirers are on the prowl, and individual buyers spurred by unemployment, are throwing their hats in the mix. What all these tax changes mean is that if you're already planning on selling your company within the next few years, it'd be worth your while to speed up that process and get on the market now. Even if you're hoping to increase valuation over the next three to five years, it's highly possible that the taxes you end up paying through that time will outweigh whatever you gained through valuation."

For life insurance agents, the most important take away is that key person policies (including term policies if convertible) may be sold in the secondary market for life insurance. In some cases, our firm has able to generate offers to sellers of key man policies in as little as 24 hours.

Keep in mind that the liquidity from selling an unwanted key person policy could provide an unexpected cash windfall to help business owners fund their retirement, or absorb any tax losses from the sale.

Jeff Hallman and Scott Thomas are co-founders and managing partners at Asset Life Settlements, a life settlement brokerage company based in Orlando, Florida. Hallman can be reached at (888) 335-4769, extension 1108, and Thomas can be reached at (888) 335-4769, extension 1115.