Little-Known Facts About Employer-Owned Life Insurance

Many companies purchase life insurance on their employees.  Employer-owned life insurance, or EOLI (also known as corporate-owned life insurance, or COLI) is most often purchased on the lives of key employees, owners, and executives.  The proceeds are typically used to recruit and train replacement personnel and/or provide liquidity to redeem stock upon the death of an owner.  EOLI is often referred to as “key person” insurance. In general, life insurance proceeds are not taxable.  However, due to abusive practices involving EOLI by some companies in the past, the IRS implemented regulations that placed limitations on the extent to which proceeds from EOLI policies are exempt from income tax.  The final regulations, which were part of the “COLI Best Practices Act,” were not released until November 6, 2008, but they applied retroactively to all employers owning EOLI policies purchased after August 17, 2006, which is the date the Pension Protection Act of 2006 was signed into law.

In order for proceeds from EOLI policies to be excluded from gross income, and therefore exempt from income tax, employers must ensure that all of the following requirements are met:

They must file IRS Form 8925  with their income tax return each year.  This form must indicate the following:

1. The employer’s total number of employees
2. The number of employees insured under EOLI contracts at the end of the year
3. The total amount of insurance under EOLI contracts at the end of the year
4. The name, address, and taxpayer identification number of the employer and the type of business in which it is engaged
5. Whether the employer has a valid consent for each EOLI policy

The insured employee must, prior to the issuance of the contract:

1. Be notified in writing that the employer intends to insure the employee’s life and the maximum face amount for which the employee could be insured at the time the contract is issued
2. Provide written consent to be insured under the contract during and after active employment
3. Be informed in writing if the employer will be a sole or partial beneficiary of any death benefits

One of the following Specified Exceptions must be met:

1. The insured was an employee at any time during the 12-month period before the insured’s death
2. At the time of contract issue, the insured employee was a director, or a 5% or greater owner of the business at any time during the preceding year, or received compensation in excess of $95,000, adjusted for future inflation, in the preceding year, or was one of the five highest-paid officers, or was among the highest-paid 35% of all employees.

If any of the above conditions are not met, the proceeds from an EOLI contract could be taxable to the employer, which could be a very costly mistake.

Owning life insurance on key employees can make good financial sense for many employers, but as you can see, it’s not necessarily a simple, buy-it-and-forget-about-it transaction.  Contact your tax advisor if you have any questions about IRS Form 8925 or the tax implications of owning EOLI contracts.  Contact us if would like more information about the benefits of employer-owned life insurance.