Changes that Congress made to the tax law in 2006 are having an impact on small business owners who have employer-owned life insurance on the lives of any employee (including the owner who is an employee). Any employer-owned policy purchased after August 17, 2006 may be subject to income tax on the insurance proceeds. This has been, and will be, shocking news to many business owners.
Small employers rarely can afford to have staff keep track of the law changes that may impact their business. Unfortunately, sometimes they are not aware of changes that can cost them serious tax dollars. That is the case for many small business owners when it comes to employer-owned life insurance purchased after August 17, 2006.
Reasons for EOLI
Small employers have found it advantageous to own life insurance on the lives of select employees. The following are some of the reasons:
? Key man protection
? Deferred compensation planning
? Endorsement split-dollar
? Collateralizing loans
? Non-qualified retirement programs
The new statute will impact all such plans and any other employer-owned arrangement. An “employer-owned life insurance contract” is a policy owned by a “person” engaged in trade or business; the contract insuring the life of an individual who is an employee of the “person” on the date the insurance contract is issued. The “person” can be a sole proprietor, partnership, LLC, S Corporation, C Corporation, etc. The “person” or a “related person” must also be directly or indirectly a beneficiary under the contract. Keep in mind that the “related person” definition applies only to a beneficiary defined by the statute and is not considered an owner of the contract.
The new statute
Congress added Section 101(j) to the Internal Revenue Code in the Pension Protection Act of 2006 in response to the issuing of “janitor” insurance and other employer arrangements wherein the insured employee had not given consent to the life insurance being owned by the employer. The requirements of Section 101(j) include:
The amount of life insurance benefit excluded from the gross income of the employer (also called the applicable policyholder) shall not exceed an amount equal to the sum of the premiums and other amounts paid by the employer for the contract. The balance of the life insurance benefit is includable in gross income.
Exceptions to the general rule
If the insured employee has been given a proper notice and has signed a proper consent, the general rule will not apply to certain arrangements (a) based on an insured’s status, or (b) based on amounts paid to an insured’s heirs. Even if the policy fits within one of the two exceptions, the proper notice and consent must be completed prior to the issuance of the life insurance contract.