Introduction: Why Key Person Insurance Needs a Second Look When the Owner Is American
Key person insurance looks like the simplest contract a British company ever signs, yet for an American owner it hides one of the most expensive paperwork failures in the US tax code. Your UK broker arranges the cover in an afternoon. Your UK accountant applies the HMRC rules. However, nobody in that chain asks whether the person insured holds a US passport, and that single fact decides whether a seven-figure payout reaches your US return tax-free or fully taxable.
The problem sits in a provision most British professionals have never read. Section 101(j) of the Internal Revenue Code strips the tax-free status from company-owned life cover unless the insured signs a specific written notice and consent before the policy starts. Furthermore, the rule applies only where the insured is a United States citizen or resident. As a result, the same UK company can hold two identical policies and face two opposite American outcomes.
This guide explains how key person insurance works under HMRC practice, how the Internal Revenue Service treats the premiums and the proceeds, and how the two systems collide inside a controlled foreign corporation. In addition, it covers Form 8925, the federal excise tax on foreign premiums, the 2026 Net CFC Tested Income rules and a worked case study with real numbers. At TaxYork we prepare both the US and UK returns for American company owners, so we see where this cover goes wrong.
What Key Person Insurance Covers and Who Owns It
Key Person Insurance in Plain Terms
Key person insurance is a life or critical illness policy that a business takes out on an individual whose loss would damage its profits. The company owns the policy, pays the premiums and receives the money. Therefore the insured person and their family receive nothing from it. Investopedia's overview of key person cover describes the same structure in the American market, where the product often goes by the name keyman insurance.
The typical subjects of key person insurance include a founder, a rainmaking director, a chief technology officer or a fund manager with the client relationships. Consequently, wealthy American owners of UK companies usually sit at the centre of the arrangement, either as the life insured or as the shareholder who benefits when the company collects.
The Three Purposes That Drive the Tax Result
British tax law cares deeply about why the company bought its key person insurance. Firstly, a policy can replace lost trading profits while the business recruits and recovers. Secondly, a policy can repay a bank facility or a director's loan if the key person dies. Thirdly, a policy can protect the value of the shares held by the owners themselves.
HMRC treats the first purpose as a trading matter and the other two as capital or non-trade matters. In contrast, the United States ignores purpose almost entirely and asks a different question about ownership, consent and the nationality of the insured. Accordingly, a policy that is tax-neutral in Britain can still be taxable in America, and the reverse also holds.
What This Guide Does Not Cover
This guide deals only with key person insurance that the company itself owns and benefits from. Policies that pay out to a family, and arrangements that fund a share purchase between owners, follow separate rules and fall outside this article. Similarly, investment-linked life bonds are a different subject with their own US reporting burden.
How HMRC Taxes Key Person Insurance Premiums and Payouts
The Anderson Principles and the Two HMRC Conditions
No UK statute deals specifically with key person insurance. Instead, HMRC relies on a 1944 ministerial statement known as the Anderson principles, alongside the general rule in section 54 of the Corporation Tax Act 2009 that expenses must be incurred wholly and exclusively for the trade. HMRC sets out its practice in Business Income Manual BIM45525.
Two conditions must both be met before key person insurance premiums are deductible. The sole purpose must be to meet a loss of trading income from losing the key person, rather than a capital loss. Additionally, a life policy must be pure term cover with no investment element, and the term must not run beyond the individual's period of usefulness to the company. Whole of life and endowment policies fail, because HMRC treats those premiums as capital expenditure.
When the Payout Is Taxable in Britain
Where both conditions are met, the premiums reduce taxable profits and the payout is a trading receipt. Section 103 of the Corporation Tax Act 2009 brings insurance receipts into charge where the company deducted the related cost. Therefore a £1 million claim adds £1 million to profits, and the company pays corporation tax at the main rate of 25 per cent under the current UK corporation tax rates.
Where the conditions fail, the premiums are not deductible and the receipt is generally not taxed as trading income. However, HMRC warns in the same manual that it gives no assurance on that second point. Notably, the test is whether the conditions were met, and not whether the company happened to claim the deduction. A company cannot switch off the tax on the payout simply by choosing not to deduct the premiums.
The Major Shareholder Problem
American owner-managers usually fall into a specific HMRC trap. Business Income Manual BIM45530 explains that a non-trade purpose may exist where the policy covers directors who are major shareholders but not other employees. The reasoning is simple. A payout on the death of a controlling shareholder protects the value of that person's shares as much as the trade.
HMRC cites the tribunal decision in Beauty Consultants Ltd, where premiums on policies covering shareholder-directors were disallowed in full. Consequently, key person insurance on a 100 per cent American owner normally produces no UK deduction and, in most cases, no UK tax on the payout. That sounds like good news. For an American owner, however, an untaxed UK receipt is exactly where the US problem begins. Finally, key person insurance written as life cover is exempt from Insurance Premium Tax, so no UK premium tax applies either.
Section 101(j): The US Rule That Turns a Tax-Free Payout Into Income
The Default Rule Limits the Exclusion to Premiums Paid
American tax law normally excludes life insurance death benefits from income. Nevertheless, section 101 of the Internal Revenue Code carves out employer-owned life insurance contracts in subsection (j), and company-owned key person insurance is the classic example. For those contracts, the excluded amount cannot exceed the premiums and other amounts the policyholder paid. Everything above that figure is ordinary income.
The rule applies to contracts issued after 17 August 2006. An employer-owned contract is one owned by a person engaged in a trade or business, which is a beneficiary of the policy, covering someone who is an employee when the contract is issued. Importantly, the statute defines employee to include officers and directors, so a non-executive American director counts.
The Citizen or Resident Test That Makes This a Cross-Border Rule
One definition transforms this from a domestic rule into a cross-border trap. Section 101(j)(5) defines the insured as an individual covered by the contract who is a United States citizen or resident. Therefore key person insurance on a British director with no US status falls outside section 101(j) altogether, and the ordinary exclusion applies in full.
In contrast, a policy on an American founder, an American chief operating officer or a green card holder working in London falls squarely inside it. Because no British insurer, broker or accountant applies a nationality test to key person insurance, the consent paperwork is almost never produced in the UK market. We regularly review key person insurance files for American-owned companies and find nothing on the US side at all.
Notice and Consent: Three Written Steps Before Issue
The exclusion survives only if the company completes three steps in writing before the contract is issued. The company must notify the individual that it intends to insure their life and state the maximum face amount. The individual must consent in writing to being insured, including consent that cover may continue after their employment ends. Furthermore, the company must inform the individual in writing that it will be a beneficiary of the proceeds.
IRS guidance in Notice 2009-48 adds practical detail. The contract must be issued within one year of the consent. Electronic consent is acceptable where the system records a signature and can produce a hard copy. A vague reference to the maximum insurable amount fails, because the notice must state a figure or a multiple of salary.
Owner-Managers Get No Exemption
Many owners assume that signing the application form proves they knew about the policy. The IRS rejects that argument directly. Question 7 of Notice 2009-48 confirms that an owner-employee of a wholly owned corporation must still give written notice and consent, and that actual knowledge cannot replace the written requirement.
Consequently, an American who owns every share, sits as sole director and personally chose the policy still fails the test without the document. Even with valid consent, the insured must also fit a statutory category. The exclusion applies where the insured was an employee within twelve months before death, or was a director or highly compensated employee when the contract was issued. Most people covered by key person insurance qualify easily, so the consent is nearly always the point that fails.
Why a Missed Consent Is So Hard to Repair
Section 101(j) contains no correction mechanism. The IRS will overlook an inadvertent failure only where the company made a good faith effort, such as a formal system for collecting consents, and corrected the failure by the due date of the return for the year the contract was issued. Moreover, the notice states that a missing consent cannot be corrected after the insured has died.
For older key person insurance, the realistic repair is therefore a replacement contract with the consent signed first. That means fresh underwriting at an older age, so the cost of delay rises every year. Similarly, a material increase in the sum assured creates a newly issued contract for these purposes, and it needs its own notice and consent unless a valid one already covers the higher figure.
How Key Person Insurance Reaches Your US Return Through a UK Company
Your UK Company Is Probably a Controlled Foreign Corporation
A UK private company in which US shareholders own more than half the shares is a controlled foreign corporation. Each US shareholder with at least 10 per cent reports it annually on Form 5471. The company files no US return of its own. However, its income is recalculated under American tax principles to work out what the shareholder must include.
That recalculation is where section 101(j) bites. The company's income for US purposes follows the rules that would apply to a domestic corporation, so a payout that fails the consent test becomes gross income of the company. As a result, a key person insurance claim can flow straight onto the American owner's personal return, even though the cash never left the UK company.
NCTI in 2026: The Payout Flows to You Personally
From 2026, the former GILTI regime operates as Net CFC Tested Income. The owner computes the inclusion on Form 8992, and the old allowance for a return on tangible assets has gone. Therefore nearly all of a trading company's profit is tested income unless an exclusion applies. Our guide to Form 8992 and the NCTI charge on your UK company walks through the full calculation.
An individual who makes no election pays tax on that inclusion at ordinary rates of up to 37 per cent, with no deduction and no credit for the UK corporation tax. Alternatively, the section 962 election taxes the inclusion at the 21 per cent corporate rate after a 40 per cent deduction, with a credit for 90 per cent of the UK tax. Either way, a taxable insurance receipt is an expensive item to add.
How an Untaxed UK Receipt Breaks the High-Tax Exclusion
Most profitable UK companies owned by Americans rely on the high-tax exclusion. Where the effective foreign rate on tested income exceeds 18.9 per cent, the owner can elect to exclude it, and a company paying 25 per cent UK corporation tax clears that hurdle comfortably. Consequently, many owners report no inclusion at all.
A failed consent can destroy that position in a single year. The exclusion test compares UK tax paid with income measured under US rules. If Britain does not tax the payout but America counts it as income, the denominator balloons while the tax stays the same. The effective rate collapses, the exclusion fails for the whole company, and ordinary trading profits become taxable in America alongside the payout.
The Premiums Are Never Deductible in America
The US position on key person insurance premiums is blunt. Section 264 of the Internal Revenue Code denies any deduction for life insurance premiums where the taxpayer is directly or indirectly a beneficiary of the policy. Therefore, even where HMRC allows the premiums, the American calculation adds them back.
The amounts are usually small, yet they create a permanent difference between UK taxable profits and US tested income. In addition, a compliant tax-free payout still increases the company's earnings and profits. A later dividend of that money is taxable to the American shareholder, although UK dividend tax under the current UK tax on dividends rules normally generates enough foreign tax credit to cover the US charge.
If the Company Is a Disregarded Entity
Some American owners file Form 8832 to treat their UK company as a disregarded entity. In that case, the owner is treated as holding the policy directly. Notice 2009-48 confirms that a policy a sole proprietor owns on their own life is not an employer-owned contract, so the owner's own cover escapes section 101(j).
However, key person insurance on any other American employee or director remains within the rule, and a failed consent puts the taxable payout directly on the owner's Form 1040. No high-tax exclusion and no corporate layer soften the result. Accordingly, entity classification changes who is exposed, but it never removes the need for the paperwork.
Form 8925, Excise Tax and the Other US Filings
Form 8925 and the Annual Reporting Duty
Section 6039I requires every policyholder that owns an employer-owned contract issued after 17 August 2006 to report it each year. The return is Form 8925, which states the number of employees, the number insured, the total cover in force and whether a valid consent exists for each insured person.
The form attaches to the policyholder's income tax return. A UK company with no US return has nothing to attach it to, and IRS guidance does not address a foreign policyholder directly. In our practice we therefore capture the Form 8925 data every year and keep it with the Form 5471 working papers. Where the company is a disregarded entity, the owner is the policyholder and the form goes with the personal return.
The Federal Excise Tax on Premiums Paid to a UK Insurer
Section 4371 of the Internal Revenue Code imposes a 1 per cent federal excise tax on life insurance premiums paid to a foreign insurer. The charge applies where the policy covers the life of a US citizen or resident, wherever that person lives. Consequently, UK key person insurance on an American director is within its scope in principle, and the tax is reported on Form 720.
Fortunately, the US-UK income tax treaty covers this excise tax and can exempt premiums paid to a qualifying UK insurer. The exemption depends on the insurer's own treaty status and on its reinsurance arrangements, so it should be confirmed and recorded. The IRS collection of UK treaty documents holds the treaty text and technical explanation. Our tax treaty optimisation service documents positions of this kind.
FBAR and Form 8938: Where Term Cover Sits
Pure term key person insurance has no cash surrender value, so it is not a reportable account in its own right. In contrast, a whole of life or investment-linked policy with a cash value is a foreign financial account. An American who owns more than half the company must then report the company's accounts, including that policy, under the FinCEN foreign account reporting rules.
Similarly, Form 8938 picks up the shares in the UK company itself. Missed reporting of this kind often surfaces only when an owner asks us about a policy. Our FBAR and FATCA reporting service deals with those gaps, and owners with several missed years can also read about IRS Streamlined Filing for catching up.
Critical Illness Cover and Policy Definitions
Many UK key person insurance policies add critical illness benefit to the life cover. A critical illness payout is not a death benefit, so section 101 does not govern it. Any US exclusion must instead come from the accident and health insurance rules, and the position for a corporate policyholder is less settled. Therefore we treat a critical illness claim as an open point that needs analysis before the return is filed.
A further technical point concerns section 7702, which defines a life insurance contract for US purposes. UK policies are not drafted with those tests in mind. Nevertheless, the statute still treats the pure death benefit of a non-qualifying contract as life insurance proceeds, so term cover rarely causes difficulty here.
Case Study: A £2 Million Key Person Insurance Claim With No Consent
The Facts
This illustrative case study uses rounded figures in sterling, although the US return is prepared in dollars. Daniel is a US citizen living in London. He owns 100 per cent of a UK software consultancy that earns £900,000 of taxable profit a year and pays £225,000 of corporation tax at 25 per cent. Each year he elects the high-tax exclusion, so he reports no NCTI.
Rachel, also a US citizen, is the company's chief operating officer and a director. She owns no shares. In 2022 the bank required the company to insure her life for £2 million as security for a £2 million growth facility. The UK broker arranged ten-year term key person insurance. Nobody mentioned section 101(j), and Rachel signed no notice and consent. Premiums totalled £18,000 by the time she died in 2026.
The UK Result
The policy existed to repay a loan, which is a capital purpose. Accordingly, the company claimed no deduction for the premiums, and the £2 million receipt is not a trading receipt. The UK corporation tax bill for the year stays at £225,000. From a British perspective, the key person insurance did its job cleanly.
The US Result Without Consent
In America, section 101(j) limits the exclusion to the £18,000 of premiums paid. Therefore £1,982,000 becomes income of the company under US principles. Tested income before tax rises from £900,000 to £2,882,000, while UK tax remains £225,000. The effective rate falls from 25 per cent to 7.8 per cent, far below the 18.9 per cent threshold, so the high-tax exclusion fails for the whole year.
Without a section 962 election, Daniel includes £2,657,000 after deducting the UK tax. At 37 per cent, the federal bill is roughly £983,000. With the election, the taxable amount is 60 per cent of £2,882,000, or £1,729,200. Tax at 21 per cent comes to £363,132, and a credit of £202,500 for 90 per cent of the UK tax leaves about £160,600. Furthermore, later dividends of the same money face a second layer of tax.
The Same Claim With a Signed Consent
Had Rachel signed a one-page notice and consent before the key person insurance started, the full £2 million would be excluded. Tested income would remain £900,000 at a 25 per cent effective rate, the high-tax exclusion would apply, and Daniel's inclusion would be nil. The document would have saved between £160,600 and £983,000.
Notably, the same result follows with no paperwork at all if the insured is British. Had the bank insured the UK-national chief technology officer instead, section 101(j) would never have applied. The whole exposure turns on one American passport and one missing signature.
A Practical Checklist for American Owners Before the Policy Starts
Before the Policy Is Issued
Start by identifying every insured person who is a US citizen, green card holder or US tax resident. For each one, prepare a written notice stating the maximum sum assured, the company's status as beneficiary and the fact that cover may continue after employment ends. Then obtain the signed consent and date it before the policy's start date.
Additionally, ask the UK accountant to record the purpose of the cover in a board minute. That minute supports the HMRC treatment of the key person insurance premiums. It also tells the US preparer whether Britain will tax a future claim, which decides how the claim interacts with the high-tax exclusion.
Every Year After That
Keep the consent with the company's statutory records and give a copy to your US preparer. Record the key person insurance in force each year for Form 8925 purposes. Moreover, tell both advisers before you increase the sum assured, replace the insurer or extend the term, because each change can create a newly issued contract.
If You Already Have Cover in Place
Review any existing key person insurance on an American life now, while the insured is alive. Where no consent exists and the correction window has closed, compare the cost of a replacement policy with the tax at risk. In most cases the extra premium is trivial beside the exposure. Above all, do not wait for a claim, because nothing can be repaired afterwards.
How TaxYork Can Help
TaxYork prepares US and UK tax returns for American company owners, investors and senior executives in Britain. We review existing key person insurance against section 101(j), draft the notice and consent wording for your company to issue, and model how a claim would affect your Form 5471, Form 8992 and high-tax exclusion. In addition, we coordinate the HMRC treatment of premiums with your UK corporation tax return.
Because we prepare both sides, nothing falls between two firms. Our US tax returns for expats service covers the full personal filing, including the company forms. Furthermore, where we find missed US tax returns or missed reporting behind a policy review, we bring every year up to date in a single engagement.
Conclusion
A British company can arrange key person insurance in a day, and HMRC's rules on it are well understood. The American rules are neither. Section 101(j) applies only where the insured is a US citizen or resident, demands written notice and consent before issue, and offers almost no route to repair a failure. Consequently, the same policy can be tax-free in Britain and fully taxable on your US return.
The cost of getting this right is one signed page. The cost of getting it wrong can run to hundreds of thousands of pounds, and it can pull ordinary trading profits into US tax in the same year. Therefore every American owner of a UK company should check the file before the next renewal.
Contact Us
Speak to our team before you buy, renew or increase key person insurance on an American life. You can book a consultation online, email hello@taxyork.com or call 020 3488 8606. We will review your policy documents, confirm the US and UK treatment, and prepare the filings that go with them.
Disclaimer
This article provides general information only and does not constitute tax, legal or financial advice. Tax rules in the United States and the United Kingdom change frequently, and their application depends on your individual circumstances. The case study is illustrative and uses rounded figures. You should obtain professional guidance on your own position before acting. TaxYork accepts no liability for any loss arising from reliance on this article. Contact hello@taxyork.com or 020 3488 8606 to discuss your situation.