Understanding Corporate‑Owned Life Insurance (M‑3) for Businesses

What is corporate‑owned life insurance (M‑3)?

Corporate‑owned life insurance, often referenced as an M‑3 policy, is a life insurance contract where a business—not an individual—acts as the policyholder, beneficiary, and payer of premiums. The arrangement allows a company to protect against the financial loss that can arise from the death of a key employee, founder, or other insured individual whose contributions are vital to the organization's continuity.

Why businesses use M‑3 policies

Companies typically purchase M‑3 policies for three strategic reasons: funding buy‑sell agreements, covering key‑person loss, and providing tax‑efficient financing for employee benefits. In a buy‑sell context, the death benefit supplies cash to purchase a deceased owner's share, preventing disruption among remaining partners. For key‑person coverage, the payout can offset lost revenue, cover recruitment costs, or repay debt that was guaranteed by the insured executive. When structured correctly, the policy can also serve as a tax‑advantaged source of capital for non‑qualified deferred compensation plans.

Tax implications and the M‑3 designation

The "M‑3" label stems from IRS guidance on corporate‑owned life insurance (COLI). Premiums paid by the corporation are generally not deductible as a business expense because the policy is considered a personal benefit to the insured. However, the death benefit received by the corporation is usually excluded from taxable income, provided the policy meets certain requirements—most notably that the insured is a non‑employee or that the policy is not transferred for a valuable consideration.

When the insured is an employee, the policy may be subject to the "transfer‑for‑value" rule, which could render the death benefit partially taxable. Companies often mitigate this risk by structuring the policy as a "non‑transferable" COLI or by ensuring the insured's compensation is below the IRS threshold for "key‑person" status.

Types of policies used in M‑3 arrangements

Most corporate‑owned life insurance policies are either whole life or universal life contracts. Whole life offers guaranteed cash value growth and a fixed premium, making it suitable for long‑term buy‑sell funding. Universal life provides flexible premiums and adjustable death benefits, which can be advantageous for companies seeking to align cash flow with fluctuating financial conditions.

Key considerations before implementing an M‑3 policy

• Insured selection: Choose individuals whose loss would materially affect the business, such as founders, CEOs, or partners with ownership stakes.
• Policy ownership: Ensure the corporation is the clear owner, beneficiary, and payer to avoid unintended tax consequences.
• Funding strategy: Determine whether premiums will be paid from operating cash flow, a dedicated reserve, or a separate financing arrangement.
• Regulatory compliance: Review state insurance regulations and IRS rules on COLI to confirm eligibility for tax‑free death benefits.
• Exit planning: Align the policy's death benefit with the valuation method used for buy‑sell agreements to avoid shortfalls.

Comparative overview of policy features

Implementation steps for a corporate‑owned M‑3 policy

1. Conduct a needs analysis to identify key individuals and quantify the financial impact of their loss.2. Choose the appropriate policy type based on cash‑flow projections and buy‑sell agreement terms.3. Draft corporate resolutions that authorize the purchase, designate the corporation as owner/beneficiary, and outline premium payment responsibilities.4. Work with an experienced insurance broker and tax advisor to structure the policy in compliance with IRS COLI rules.5. Review the policy annually to ensure coverage levels remain aligned with business growth and ownership changes.