Are You In Compliance With The Employer-Owned Life Insurance Contract Rules?

It is common for companies to carry life insurance on its owners and certain key-employees to help lessen the financial strain on the company should an unfortunate death of one of these individuals happen. When the company insures the life of its owners and key-employees, the policies are referred to as “employer-owned” insurance contracts, where the company is both the owner and beneficiary of the policy.

Most companies are familiar with the rules concerning the deductibility of employer-owned life insurance premiums and the rules regarding taxable income upon the collection from a life insurance policy. Pursuant to Internal Revenue Code (“IRC”) Section 101(j), amounts received from employer-owned life insurance contracts on owners and key employees are generally (certain conditions apply) excluded from taxable income.  Similarly, the company is not allowed to deduct any of the premiums paid on those policies for income tax purposes.

One requirement of IRC Section 101(j) that may be overlooked is the notice and consent requirement. IRC Section 6039I provides additional rules for life insurance policies issued after August 17, 2006. Failure to comply with these requirements may result in all or a portion of the insurance proceeds to be taxed to the company, since the proceeds would not meet the income exclusion rules.

Under the notice and consent requirements of IRC Section 101(j) and 6039I (also see Federal Form 8925), the employee whose life is to be insured must, before the contract’s issue date:

1.Be notified in writing that the “applicable policyholder” (i.e., generally, the employer or a “related person,”) intends to insure the employee’s life. The maximum face amount for which the employee could be insured at the time the contract was issued must also be revealed;

2. Be notified in writing that the life insurance coverage may continue after the “insured” terminates employment;

3. Provide written consent to being insured under the contract, including for coverage that continues after the insured terminates employment; and

4. Be informed in writing that an applicable policyholder will be a beneficiary of any proceeds payable upon the employee’s death.

For more information on employer-owned life insurance contract rules, please contact John F. Martin, CPA/PFS, CFP® at 315-472-9127 or jmartin@dmcpas.com