Reporting for Employer-Owned Life Insurance Contracts

March 2009

Information Reporting for Employer-Owned Life Insurance Contracts

Any portion of the death benefit that exceeds the premiums paid represents taxable income, unless the employer complies with certain notice and consent requirements

It is not unusual for a business to purchase insurance on the life of an employee. A common use for company-owned life insurance is to provide a source of funds to buy out the equity of an employee-owner in the event of an untimely death. In other cases, the insurance is used for “key person” protection.

Historically, life insurance death benefits have been tax-free if collected by an employer. But new tax law and IRS regulations threaten this exemption in some cases.

The IRS recently issued regulations (Reg. § 1.6039I-1) that require employers to file a tax schedule disclosing information on employer-owned life insurance (EOLI) contracts. An EOLI contract is a life insurance contract that (a) is issued after August 17, 2006, (b) is owned by an employer engaged in a business that is a beneficiary of the policy, and (c) insures the life of an employee. The regulations, which apply to tax years ending after November 6, 2008, relate to a change in the tax code that occurred in 2006.

In a nutshell, any portion of the death benefit that exceeds the premiums paid represents taxable income, unless the employer complies with certain notice and consent requirements set forth in IRC §101(j)(2). Life insurance death benefits remain tax-free if:

the employer notifies and secures the written consent of the employee to the insurance prior to placement of the policy, and
the policy is for a typical business need, such as key person protection or funding a buy-sell agreement.

In addition, every employer owning one or more EOLI contracts issued after August 17, 2006, must file a return with the IRS on Form 8925, “Report of Employer-Owned Life Insurance Contracts.” This form discloses the status of the EOLI policies owned by the employer.

The new IRS regulations address only the information reporting on Form 8925. They do not address the requirement under IRC §101(j)(2) that, in order to receive tax-free death benefits, an employer must notify the employee and secure his or her written consent prior to the issuance of any EOLI policy issued after August 17, 2006. The IRS is considering publishing guidance that will address these requirements.

In the interim, if you obtain a new EOLI contract, you should be certain to comply with the employee notice and consent requirements of the new law. If you maintain EOLI contracts issued after August 17, 2006, you may wish to document that your employees have since been notified and consent to the EOLI contracts (although we are not yet aware of any guidance by the IRS that such documentation will constitute acceptable notice and consent). Alternatively, you should consider exchanging the old EOLI contracts for new EOLI contracts after complying with the new notice and consent requirements.

Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market.