More On Tax Planningfrom The Advisor's Professional Library
- IRAs: In General Individual Retirement Accounts are highly popular tools for contributing funds that grow on a tax deferred basis. Depending on the type of IRA, the accumulation can be tax free.
- Updating Form ADV and Form U4 When it comes to disclosure on Form ADV, RIAs should assume information would be material to investors. When in doubt, RIAs should disclose information rather than arguing later with securities regulators that it was not material.
The IRS issued a letter ruling earlier this year that may clear up an issue on certain corporate-owned life insurance policies. The letter noted that while a certain employer did not obtain separate documentation to exclude death benefits on employer-owned life insurance, the agreement between it and its employees was enough to qualify for exclusion of those death benefits.
A taxpayer (let’s call it Acme) was a closely-held corporation whose employees were its stockholders. Acme and each shareholder entered into an agreement to provide for the purchase of each shareholder's interest in Acme upon the death or termination of such shareholder's employment. The agreement provided that Acme would obtain life insurance on the life of each shareholder, and that Acme would be the owner and beneficiary of the life insurance. If the agreement was terminated, or a shareholder disposed of his or her interest in Acme as allowed by the agreement, a shareholder had the right to purchase from Acme any Acme-owned life insurance covering his or her life. If the life insurance was not purchased, Acme retained the right to surrender or otherwise dispose of the life insurance.
Consistent with the agreement, Acme then purchased life insurance contracts covering certain shareholders (contracts). The process of purchasing these life insurance contracts required each affected shareholder to complete an application that indicated that Acme was to be the owner and beneficiary, and the amount of coverage being obtained.
Prior to purchasing these life insurance contracts, Acme did not obtain from each affected shareholder separate documentation (e.g., a form or forms) which advised shareholders that Acme intended to insure the shareholder's life, and of the maximum face amount for which the shareholder could be insured at the time the contract was issued; provided the shareholder's consent to being insured under the contract and that the coverage may continue after the shareholder terminates employment; and informed the shareholder that Acme will be a beneficiary of any proceeds payable upon the death of the shareholder.
Acme obtained separate documentation after purchasing the life insurance contracts, but not before the due date of Acme's income tax return.
IRC Section 101(j) provides that, in the case of an employer-owned life insurance contract, the amount of death benefits excluded from gross income cannot exceed an amount equal to the sum of the premiums and other amounts paid by the policyholder for the contract.
For this purpose, an employer-owned life insurance contract is a life insurance contract that: (1) is owned by a person engaged in a trade or business and under which such person is directly or indirectly a beneficiary under the contract, and (2) covers the life of an insured who is an employee with respect to the trade or business on the date the contract is issued. An applicable policyholder is generally a person who owns an employer-owned life insurance contract or a related person.
Section 101(j)(2) provides exceptions to the exclusion limitation for certain employer-owned life insurance contracts with respect to which certain notice and consent requirements are met. Those exceptions are based either on: (1) the insured's status as an employee within twelve months of death, or as a highly compensated employee or individual, or (2) the extent to which death benefits are paid to a family member, trust or estate of the insured employee, or are used to purchase an equity interest in the applicable policyholder from a family member, trust or estate.
These exceptions apply only if the notice and consent requirements are satisfied. Notice and consent requirements are met if, before the issuance of the contract, the employee is notified in writing that the applicable policyholder intends to insure the employee's life and the maximum face amount for which the employee could be insured at the time the contract was issued, provides written consent to being insured under the contract and that such coverage may continue after the insured terminates employment, and is informed in writing that an applicable policyholder will be a beneficiary of any proceeds payable upon the death of the employee.
Acme is an applicable policyholder and the contracts are employer-owned life insurance contracts. While Acme did not obtain from each shareholder separate documentation (e.g., a form or forms) which contained all the information required, considering all of Acme's documentation as a whole, all of the requirements were met before the issuance of the contracts.
The IRS reasoned that, through the agreement and the application, each shareholder was notified in writing that Acme intended to insure the shareholder's life; they consented to being insured under the contract; and they were also informed in writing that Acme would be a beneficiary of any proceeds payable upon the shareholder’s death.
Through the application, each shareholder was notified in writing of the maximum face amount for which the shareholder could be insured at the time the contract was issued. By signing the agreement, each shareholder consented that such coverage would continue after the shareholder terminates employment.