Employer-Owned Life Insurance Policy Holders—Take Note of this Potential Tax Implication
Many business owners are unaware of the Pension Protection Act passed in 2006 and its potentially costly tax implications for beneficiaries of employer-owned life insurance (EOLI) policies. This legislation enforces a tax rate of up to 50 percent on the death benefits of EOLI policies purchased after August 17, 2006. Normally, these benefits would be tax exempt—and they still can be if the proper notice and consent forms are completed before the policy is issued.
The IRS includes key man insurance, insurance funded buy-sell arrangements, some executive compensation programs, and policies held by family entities such as a family limited partnership or a limited liability corporation in its definition of EOLI contracts. More specifically, the IRS defines an EOLI contract as “a life insurance contract that (1) is owned by a person engaged in a trade or business, and under which such person (or a related person) is directly or indirectly a beneficiary under the contract, and (2) covers the life of an insured who is an employee of the applicable policyholder on the date the contract is issued. The term ‘applicable policyholder’ with respect to an employer-owned life insurance contract generally means the person who owns the contract.”
In its Bulletin 2009-24, the IRS also specifies the term “applicable policyholder” to include any person who bears a specific relationship (defined by the IRS) to the owner of the contract, or who is engaged in trades or businesses with the owner of the contract which are under their common control.
Many of the EOLI policies affected by the Pension Protection Act were sold to small businesses who may not be aware of the potential tax obligation. Given that it is the policyholder’s responsibility to make sure that the notice and consent rules are met, if you have purchased an EOLI policy for an employee, yourself, or another stakeholder of your business, such as shareholders, it is important to take steps to avoid the possible 50% tax rate on the policy pay out.
To comply with the notification and documentation requirements for EOLI policies, the IRS requires:
If you have not met these requirements for each EOLI policy, you may want to ask your insurance carrier if you should have the policies reissued so that you can meet the notification and documentation requirements. Another avenue you can try is to apply to the Internal Revenue Service for a private letter ruling if you feel confident that you have enough documentation to satisfy the IRS requirements. However, be aware that the filing fee for such a request can be upwards of $15,000.
If you are currently considering purchasing an EOLI policy or you may buy one in the future, keep the requirements of the Pension Protection Act in mind. Make sure to have a separately executed notice and consent form from the insured employee, so there is no question about compliance and the ultimate tax-free nature of the benefit. If you have any questions about the tax implications of EOLI policies, please contact our office.
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Robert W. Morris & Company, PC
19 E Main St, PO Box 68
New Bloomfield, PA 17068