The new pension bill (H.R. 4) strikes another blow against corporate-owned life insurance. The bill, which will apply to policies issued after the day the president signs it (expected to be August 17), will restrict the tax-free status of corporate or bank-owned life insurance to a narrowed class of employees, and then only if an elaborate set of notifications are made and documented.
This is a big deal in the insurance world because it fences in the sacred tax-free status of life insurance proceeds. Many tax shelters in the 1990s were set up to game this tax-free status, including the notorious "dead peasant" policies.
The bill will add new Sec. 101(j) to the Internal Revenue Code. This provision restricts tax-free life insurance proceeds to the amount paid for the policies unless the policy is on the life of:
- Somebody who was an employee within 12 months of death; or
- A highly-compensated employee (as of the date the policy is issued). This covers 5% owners, directors, employees with over $100,000 compensation, or anybody else in the top 35% of compensation at a company.
A policy can also still be tax-free to the extent the proceeds are paid to a family member of the insured, the insured's estate, or trusts for the benefit of the insured or the beneficiary. Amounts used to fund a buy-sell agreement will also be tax-exempt, but only to the extent it's actually used to fund the buy-sell.
Even if the policy meets these new requirements, it will be taxable unless the company meets the new "notice and consent" requirements. These require:
- A written notification to the insured employee, including the maximum amount of insurance the employer might buy;
- Written notification to the employee that the employer or other policyholder will be the beneficiary of death proceeds, and
- Written employee consent to the purchase.
These have to be received before the policy is issued. As they're learning in the option world, backdating won't cut it. You will have to have the consents before you buy the policy.
The new law also will require employers with insurance on employees issued covered by 101(j) to file a new tax form each year to report information on the policies.
If you are pondering buying life insurance for your business or bank, keep an eye on the White House website to make sure he hasn't signed the bill yet. If he has, you'd better make sure your new policy qualifies, and that you have the notifications and consents in hand, before you pull the trigger on the new insurance contract.
The items included in the Tax Update Blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation.
Joe Kristan writes the Tax Update items, and any opinions expressed or implied are not necessarily shared by anyone else at Roth & Company, P.C. Address questions or comments on Tax Updates to