Life Insurance for Texas Business Owners: 6 Protection Strategies

The six strategies in one line each

1. Cross-purchase buy-sell. Each partner personally owns a life policy on every other partner. At a partner's death, the surviving partners receive tax-free proceeds and use them to buy out the deceased partner's interest. Clean step-up in basis at death for the survivors.

2. Entity-purchase (stock redemption) buy-sell. The company owns and is the beneficiary of policies on every partner. At a partner's death, the company receives the proceeds and redeems the deceased partner's interest. Simpler administratively for 4+ partners but no basis step-up.

3. Key-person insurance. Company-owned, company-beneficiary policy on a critical employee (founder, top salesperson, CTO). The death benefit replaces lost profit, comforts lenders, and funds the search for a replacement.

4. §162 executive bonus. The company pays the premium on a permanent policy owned by the executive personally. The premium is deductible to the company as compensation and taxable to the executive as W-2 income. The executive owns the policy and cash value.

5. Collateral-assignment split-dollar. The company advances premium on a policy owned by the executive. The company is repaid first from the death benefit; the excess passes to the executive's beneficiary. Useful for high-net-worth executives.

6. Personal estate liquidity. An Irrevocable Life Insurance Trust (ILIT) owns a permanent policy on the business owner. The death benefit is outside the estate and provides liquidity for federal estate tax (Texas has no state estate tax).

Texas-specific advantages

No state income tax means executive bonus arrangements net out cleaner than in California or New York. A $20,000 premium bonus costs the executive $4,400 in federal tax (22% bracket) — no state addition.

Texas Insurance Code §1108 protects cash value from business creditors when the policy is owned personally. This is a major reason most Texas business owners prefer personal ownership of the underlying policy under §162 bonus arrangements rather than corporate ownership.

Texas's strong protection of life insurance proceeds against creditors also makes the ILIT a particularly powerful estate planning vehicle for Texas business owners with significant net worth.

Choosing buy-sell structure: cross-purchase vs entity-purchase

Two partners: cross-purchase is usually simpler and produces a basis step-up that benefits the survivor at a later sale.

Three to four partners: cross-purchase requires N×(N−1) policies, which becomes unwieldy. Often a hybrid (trusteed cross-purchase) works.

Five or more partners: entity-purchase becomes substantially simpler. The basis step-up loss is real but usually outweighed by administrative simplicity.

Sole owner: buy-sell does not apply. Personal life insurance plus key-person are the relevant structures.

Common mistakes Texas business owners make

Buying personal life insurance instead of properly-structured key-person coverage when the death benefit is intended to support the business.

Funding a buy-sell with term insurance set to expire before any partner is likely to die or retire — leaving the buy-sell agreement unfunded right when it is needed.

Not updating the buy-sell agreement when the company's valuation changes. A 10-year-old agreement valued at $2M when the company is now worth $8M creates a windfall for the estate and a crisis for the surviving partners.

Owning key-person policies in a C-corporation that has high accumulated earnings — exposing the company to the Accumulated Earnings Tax on policy cash value.