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.