Employer Owned Life Insurance - It s Not Just COLI: What You Need to Know to Keep Life Insurance Income Tax Free

Transcription

1 Employer Owned Life Insurance - It s Not Just COLI: What You Need to Know to Keep Life Insurance Income Tax Free The Guardian Life Insurance Company of America, New York, NY

2 The information in this presentation is designed to be general in nature and for educational purposes only. Guardian, its agents and employees do not give tax or legal advice. For specific advice, seek and rely upon the advice of a qualified tax advisor or attorney. GEAR # Approved: Expiration

3 True or False? Life Insurance Proceeds are income tax free. q True q False ü It depends

4 Exceptions to Income Tax Free Proceeds Policies transferred for valuable consideration Unless to an exempt transferee Insured, partner of insured, partnership in which insured a partner, or a corporation in which insured is a shareholder or officer Policies owned by qualified plans Corporate Alternative Minimum Tax IRC 101(j)

5 101(j): Employer Owned Life Insurance General Rule: EOLI is income taxable 101(j)(1) In the case of an employer owned life insurance contract, the amount excluded from gross income of an applicable policyholder... shall not exceed an amount equal to the sum of the premiums and other amounts paid by the policyholder for the contract. Federal Income taxation of EOLI can only be avoided when An exception fits AND the Employer complies with specific notice and consent rules

6 EOLI Defined It s Not Just COLI A life insurance contract that is owned by a person engaged in a trade or business and under which such person (or a related person) is directly or indirectly the beneficiary under the contract and covers the life of an insured who is an employee of the applicable policyholder on the date the contract is issued.

7 Transition Rule and Section 1035 Exchanges Section 101(j) applies to contracts issued after August 17, (j) doesn t apply to a contract issued after that date pursuant to a section 1035 exchange for a contract issued on or before that date. However, any material increase in the death benefit or other material change causes the contract to be treated as a new contract and thus subject to section 101(j). Increases in death benefit because of a PUA rider issued before 8/17/2006 should NOT be a material change

8 Employer Not Just Corporations Employer is a person engaged in a trade or business C Corporations, S Corporations, LLCs, Partnerships, AND Sole Proprietorships Not just COLI

9 Employee Defined Common law employees Officers Directors Highly compensated employees Shareholders (owning 5% or more of business)

10 Acme Restaurant Supply Joe and Jane, co-owners and both key employees In 2009, Acme purchased 2 key man policies for $1M Joe and Jane Acme is owner and beneficiary In 2012, Jane dies after 3 premium payments totaling $90, (j) provisions not met Is the entire $1,000,000 death benefit income tax free?

11 Acme Restaurant Supply Result: Only $690,600 received tax free $309,400 income taxes paid $1,000,000 death benefit - 90,000 paid in premiums recovered income tax free $ 910,000 subject to taxes at corporate rate (assume 34%) x.34 $ 309,400 paid in taxes $90,000 recovery of cost $690,600 income tax free

12 Qualifying for the Exception? A. Must qualify for one of 1. Insured is a recent employee At any time during 12 months before death was an employee 2. Directors or Highly Compensated Individuals At the time of issue of policy, Insured was Director/HCE 3. Proceeds paid to Insured's heirs 4. Proceeds used to buy an equity interest in policy holder s business B. Notice and Consent of insured Prior to issuance of policy Total amount to be issued Guardian Form EOLINOTICE101j0809 Employer must maintain records and file IRS Form 8925

13 What About That Notice & Consent? Employee: is notified in writing that the applicable policyholder intends to insure the employee's life and of the maximum face amount for which the employee could be insured at the time the contact 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.

14 Qualifying for an Exception 2. Directors or Highly Compensated Individuals 5% or greater owner of the business at any time during the previous tax year Employee earning more than $110,000 in 2011 (adjusted annually under IRC 414 (q)) Employee who is one of five highest paid officers Employee who is among the 35% highest paid of all employees

15 Qualifying for an Exception 3. Proceeds paid to Insured s heirs To insured s family members To insured s designated beneficiary (not the business) To a trust established for family members To insured s estate Proceeds must be paid by the due date of the tax return for the policyholder s tax year

16 Qualifying for an Exception 4. Proceeds used to buy an equity interest in policy holders business Life insurance used by business to purchase a decedent s interest in employer Proceeds must be paid or used by the due date of the tax return for the policyholder s tax year Payment to the insured s heirs to purchase equity interest must be completed in the tax year for which business is claiming the exception

17 Annual Compliance IRS Form 8925

18 Can Past Omissions Be Fixed? IRS provision provides very little help: Employer has a system for notice and consent, failure was inadvertent and failure to obtain was discovered and corrected no later than tax return due date for tax year in which policy was issued Transfer policy to insured? Start over with a new policy Use Guardian s Rapid Application Program

19 Is it EOLI? Yes, Likely No, probably not Maybe. Assume EOLI Sole Proprietorships On proprietor On employee Yes No 162 Bonus No Key person* except for sole proprietor owning policy on self Corporation Wholly Owned by 1 SH Yes Yes

20 Is it EOLI? Non-Qualified Deferred Compensation DBO Plan Rabbi Trust Key Person Yes, Likely Yes Yes Yes Yes No, probably not Maybe. Assume EOLI

21 Buy-Sell Redemption Entity purchase Cross- Purchase Is it EOLI? Yes, Likely Yes Yes, possible under related party rule No, probably not Maybe. Assume EOLI

22 Split Dollar Economic Benefit Split Dollar (employer owned) Loan Regime (employee owns policy and equity) Split Dollar Variations (employee is named owner, employer is tax owner ) Yes, Likely Yes Is it EOLI? Yes, possible under related party rule Yes, possible No, probably not Maybe. Assume EOLI

23 Charity Owned Life Insurance On a donor Is it EOLI? Yes, Likely No, probably not No Maybe. Assume EOLI On an employee Director Qualified Plans VEBAs Yes Yes No No

24 What Next? Add EOLI review to your best practices checklist Inform all clients in trade or business of 101(j) Key person Split dollar Deferred comp Buy-Sell DBO Meet Exception Employee within 12 months of death Officer, Director or 5% Shareholder Highly Compensated Employee Proceeds paid to insured s family (within tax year) Proceeds used to buy equity in business (within tax year) Notice and Consent Annual IRS Form 8925

25 Who we are and how to get us Business Resource Center For Advanced Markets , option #3 DON T FORGET TO TURN IN EVAL/RESPONSE WITH NPN