Key Man Life Insurance and Taxation

If your business has life insurance policies on your officers or on key individuals, you should be aware of the potential tax ramifications and requirements to avoid the tax benefits. Important changes have taken place in recent years and can have a significant impact on the taxation of corporate life insurance. The information below is designed to inform you of IRS regulations that have been implemented over the past few years and what is needed to comply with those IRS requirements so that the policy proceeds avoid unnecessary taxation. 

Pension Protection and Life Insurance Taxation Act, 2006

On August 17, 2006, President George Bush signed tax legislation containing provisions that have a significant impact on the life insurance policies of key men and other employers taken out after August 17, 2006. The law, known as COLI (Corporate Owned Life Insurance) Best Practices Act (part of the Pension Protection Act 2006), includes the proposed section 101 (j) of IRC. Under this bill, life insurance death benefits for company-owned life insurance policies issued after the effective date of August 17, 2006 are taxable on income (in the the death benefit exceeds the employer's premiums) unless certain requirements are met.

This new legislation applies to all employer-owned policies issued after August 17, 2006 and includes policies used for key man insurance, share buyback plans, life insurance owned by the company. company and executive supplementary retirement plans (among others). It may also extend to the assignment of collateral (economic benefit) scheme in split dollars and split dollar loans. With this law, all situations where an employer will hold full or partial ownership of an insurance policy issued after August 17, 2006, regardless of the purpose of the policy, will have to meet certain requirements and follow specific guidelines for avoid potential taxation. .

Avoid Taxing Key Man Life Insurance

In order to prevent the proceeds of the contract (death benefits) from being taxable on income, the following two conditions must be met:

1. Notice and Consent Requirements:

a) The employee must be notified (in writing), before the life insurance policy is issued, that the employer intends to purchase a policy on his life and to disclose the maximum face amount which is asked about his / her life is;

 (b) The employee must give his written consent to be insured and agree that the employer can choose to continue the policy even after the employee leaves employment; and

c) The employee must be notified in writing that the employer is the beneficiary of all or part of the proceeds of the death benefit.

Under the COLI Best Practices Act, unless the employer provides written notice and obtains the employee's written consent before the policy is issued, the death benefit of the life insurance policy will be taxable from day 1. Notice and consent can only be obtained after the life insurance policy is issued to remove this status as a taxable death benefit.

2. Once the “notice and consent requirements” are met, there are two “exceptions” to the tax rule for proceeds of death payable to an employer, one of which must be met:

a.) Exception n ° 1:

1) The insured was an employee at all times during the 12 month period preceding the death of the insured OR

2) The insured was a director or “highly paid employee” at the time of contract issuance.

b.) Exception # 2:

Any amount received by the employer following the death of the insured is paid to:

1) A member of the insured's family;

2) A designated beneficiary of the insured under the contract other than the employer;

3) A trust established for the benefit of a family member, another designated beneficiary or the estate of the insured; or

4) A family member, designated beneficiary, trust or estate in exchange for any interest they hold in the company / employer (ie buy-sell agreement).

If the "notice and consent requirements" and one of the "exceptions" above are met, life insurance proceeds owned by a corporation would be received tax-free if the benefits of death of the policy were otherwise eligible for favorable tax treatment.

COLI Best Practices Act - Reporting Requirements

All employers are required to report all company-owned life insurance policies to the IRS annually. The annual report requirements imposed under IRC Sec. 6039 I include:

1) The total number of employees at the end of the year;

2) The number of employees insured under the COLI scheme at the end of the year;

3) The total amount of insurance in force on all insured employees at the end of the year; and

4) The name, address, taxpayer identification number and type of business of the employer, and

5) A valid declaration of consent for each insured employee (or, if all required consents are not obtained, the number of insured employees for whom consent has not been obtained).

The IRS requires this report annually on Form 8925 "Report of Employer-Owned Life Insurance Contracts." This is a simple form and must be completed to comply with the IRS code. You should consult your CPA or professional tax advisor immediately for more information on Form 8925 and IRS reporting requirements.

If proper record keeping and reporting is not kept, all products from a key man's life insurance policy or other company-owned life insurance death benefits may be submitted. to income tax.

In conclusion

Company-owned life insurance policies, including key life insurance policies issued after August 17, 2006, may have death benefits subject to income tax if certain conditions are not met. respected. The Pension Protection Act of 2006, which includes the COLI Best Practices Act, includes provisions that have significant consequences for the key man and other employer-owned insurance taken out after August 17, 2006. You should understand the requirements in notice and consent, as well as exceptions. and record keeping and reporting requirements and IRS compliance so that key man insurance policy proceeds avoid unnecessary taxation. Unfortunately, if you have a key man policy issued after August 17, 2006 and you haven't, your best bet for avoiding potential income tax might be to delete your current policy and start over!

* All of the above tax information is for informational purposes only and is provided to explain the basic tax treatment of life insurance based on the Internal Revenue Code. Anyone or entity considering a life insurance policy should consult their own CPA or tax / legal advisor who understands their particular tax situation and the rules governing their condition. In any case, this information is not intended to be tax or legal advice.