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Wednesday, December 30, 2009

Do sole proprietors need life insurance?

Using sole proprietorship as a business structure is popular because it is the simplest form of business to set up and operate. The business owner is very much integrated with the business. For example, there is no separate business tax return for a sole proprietorship; the profits are included in the individual owner's income tax return.

When a sole proprietor dies, his or her business assets such as equipment, bank accounts, inventory, vehicles and buildings, become part of his or her estate along with personal assets such as his or her home and personal savings.

The individual will not have to pay capital gains tax when his or her home is sold by the estate, but there will be tax payable when other capital assets that were used by the business are sold. That tax has to be paid by the individual's estate. There might also be expenses involved in the winding down of the business, cancelling of leases and contracts, and selling of assets. These have to be paid from the estate as well.

The concern is that there might not be enough money in the estate to pay for taxes and expenses arising from the closing of the business without having to tap into the business owner's strictly personal assets such as his or her home.

One way to ensure that there is extra money available to pay for taxes is for the sole proprietor to own a life insurance policy on his own life that names his estate as the beneficiary. Then when he passes away, the insurance company pays the policy proceeds to the estate and the executor can use the money for expenses. As I have said before in this blog, life insurance is not the answer for everyone. However it is frequently used as a way of creating new cash in an estate and is worth considering for sole proprietors.

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