LIFE INSURANCE TAXED? 101(J) Millennium Brokerage Group

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1 LIFE INSURANCE TAXED? 101(J) Millennium Brokerage Group

2 WHAT TO EXPECT... Death benefits on policies insuring employees of a business will be taxed as income unless the new rules are followed. 101(j) applies to all policies purchased on or after August 17, 2006, as well as to material modifications of policies purchased prior to that date( the IRS is not clear, but this seems to apply to DB increases). For the DB to be excluded from gross income you must insure an Appropriate Insured. ONE of six qualifiers must be met. ALL, five of five, Disclosure and Consent Requirements must be met. These must be in place prior to the Policy s issue. Additionally Annual Reports, containing ALL five elements are required by the IRS to maintain compliance. For those who have Non-Compliant coverage in place, there may be a way to bring their policy into Compliance. A business owner seeking to repair an EOLI arrangement may want to consult with a tax advisor to see if one of the following remedies might work: (i) reissue, (ii) increase death benefit, or (iii) transfer.

3 MORE INFORMATION... Employer Owned Life Insurance Requirements. Millennium s Virtual Sales Library Specimen Notice of Participation and Consent. Millennium s Virtual Sales Library The New Law for Business Life Insurance: Understanding Section 101(j) and Repairing Noncompliance. ING Attorney, David Houston, JD. Principal s Buy-Sell Review and Business Valuation. secure02.principal.com/efpframework/efpstatic.do?contentid=36084&cat=individual% 20Solutions&Tier1=Life%20Insurance&Tier2=1472&Im=7962&Is=7995&Img=8349

4 EMPLOYER OWNED LIFE INSURANCE REQUIREMENTS What Is an Employer-Owned Life Insurance Contract? An employer-owned life insurance contract is a policy owned by a person or an entity engaged in a trade or business that employs the person insured by the policy and who is direct or indirect beneficiary of the employer-owned life insurance contract. Requirements for Employer-Owned Life Insurance Contracts Entered into After August 17, 2006: If certain requirements under IRC section 101(j) are not met, the death benefits of an employer-owned life insurance contract entered into after August 17, 2006 will generally be taxable income to the employer to the extent the death benefit proceeds exceed the premiums paid. In order to maintain the income-tax-free status of employer-owned life insurance death benefits, the following requirements must be met:

5 EMPLOYER OWNED LIFE INSURANCE REQUIREMENTS CONT. Before the employer-owned life insurance contract is issued, the employer must meet certain notice and consent requirements. The employee who is to be insured must be notified in writing that the employer intends to insure the employee s life. The notice must include the maximum face amount for which the employee s life could be insured, as well as state that the policyowner (the employer) will be the beneficiary of the policy s death proceeds. Finally, the employee who is to be insured must give his/her written consent to be insured by the contract and to the insurance coverage continuing after the insured employee terminates employment; and In relation to the date of death, the insured must have been an employee of the employer at any time during the 12-month period prior to the date of death or have been a director or highly-compensated employee at the time the contract was issued. Alternatively, assuming the notice and consent requirements are met, the death benefit will not be included in the employer s income if the proceeds are paid to a member of the insured s family, the designated beneficiary of the insured under the contract (other than the policyowner), a trust benefiting a member of the employee s family or designated beneficiary, the insured s estate, or if the proceeds are used to purchase an equity interest in the business (e.g., through an entity purchase buy-sell plan).

6 EMPLOYER OWNED LIFE INSURANCE REQUIREMENTS CONT. Finally, the Pension Protection Act of 2006 imposed new reporting requirements on employer-owned life insurance contracts. For tax years ending after November 13, 2007, all employers owning one or more employer-owned life insurance contracts issued after August 17, 2006 must file Form 8925 with the IRS for each year the contract(s) is owned. Requirements for Employer-Owned Life Insurance Contracts Entered into Before August 18, 2006: Employer-owned life insurance contracts entered into before August 18, 2006 are subject to the rules that apply to life insurance contracts in general, meaning that the entire death benefit paid in a lump sum is usually exempt from income tax, regardless of who is the beneficiary. The income tax exemption, however, remains subject to the transfer-for-value rules. Note: In order to avoid unintended tax consequences, consult with your legal and tax advisors when considering the purchase of new employer-owned life insurance or the modification of existing employerowned life insurance or the modification of existing employer-owned life insurance contracts entered into before August 18, VSA, LP The information, general principals and conclusions presented in this report are subject to local, state and federal laws and regulations, court cases and any revisions of the same. While every care has been taken in the preparation of this report, neither VSA, L.P. nor The National Underwriting Company is engaged in providing legal, accounting, financial or other professional services. This report should not be used as a substitute for the professional advice of an attorney, accountant, or other qualified professional.

7 IMPORTANT NOTE: Effective with enactment of the Pension Protection Act of 2006 on August 17, 2006, section 101(j)(5) of the Internal Revenue Code requires that employees to be covered by employer-owned life insurance policies be provided with a notice and give their consent to be insured BEFORE the issue date of the policy. Failure to do so could result in the death benefit being taxable income to the applicable policyholder (generally the employer) to the extent the proceeds at death exceed the total premiums and any other amounts paid by the policyholder for contract. Furthermore, section of the Internal Revenue Code requires that employers owning one or more employer-owned life insurance contracts issued after August 17, 2006 file a return each year that includes, among other things, the number of employees insured under such contracts, the total amount of insurance in force, and that the employer must notify the IRS that it has provided the necessary notice and obtained the necessary consents before the issuance of any employer-owned life insurance contracts. It is also the employer s responsibility to keep and maintain the records necessary to show that the requirements of Section 101(j)(5) have been met. The Specimen Notice of Participation and Consent that follows on the next page is intended to comply with section 101(j)(5) of the Internal Revenue Code. However, there may also be state-specific notice and consent requirements that must be met with regard to employer-owned life insurance contracts. Any such state-specific requirements are not reflected in the specimen document that follows. Furthermore, the specimen that follows is a quick reaction to the August 18 effective date of section 101(j)(5). There may be future input from the Treasury Department/IRS that provides more in-depth guidance on the notice and consent forms. It is important the this actual Notice of Participation and Consent used be prepared by a qualified attorney and modified to reflect the unique facts of the situation and to comply with any applicable state law. VSA, LP This is a specimen document only. The actual document used in any particular case must be prepared by a qualified attorney and modified to reflect the unique facts of the situation and to comply with the applicable state law.

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9 UNDERSTANDING SECTION 101(J) AND REPAIRING NONCOMPLIANCE ING Article written by David Houston, JD. Please download the complete article at ContentID=68

10 BUY-SELL REVIEW / BUSINESS VALUATION Principal Financial Group offers at free Buy-Sell Review and Business Valuation. Download samples of these valuable tools at