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October 23, 2007

You normally can't deduct life insurance premium payments. Some insurance promoters have apparently been telling taxpayers they can get around this by having their company buy the cash-value policies through a welfare benefit plan under Section 419.

Last week the IRS said that not only do these plans not work, they are also "listed transactions" subject to additional reporting requirements and penalties for non-reporting. The IRS issued its guidance in three pieces:

Revenue Ruling 2007-65
Notice 2007-83
Notice 2007-84.

From Notice 2007-83:

Those advocating the use of these plans often claim that the employer is allowed a deduction under § 419(c)(3) for its contributions when the trustee uses those contributions to pay premiums on the cash value life insurance policies, while at the same time claiming that nothing is includible in the owner's gross income as a result of the contributions (or, if amounts are includible, they are significantly less than the premiums paid on the cash value life insurance policies). They may also claim that nothing is includible in the income of the business owner or other key employee as a result of the transfer of a cash value life insurance policy from the trust to the employee, asserting that the employee has purchased the policy when, in fact, any amounts the owner or other key employee paid for the policy may be significantly less than the fair market value of the policy. Some of the plans are structured so that the owner or other key employee is the named owner of the life insurance policy from the plan's inception, with the employee assigning all or a portion of the death proceeds to the trust. Advocates of these arrangements may claim that no income inclusion is required because there is no transfer of the policy itself from the trust to the employees.

If you are looking to buy business-owned insurance through a welfare-benefit plan, with an eye on deducting the premiums, think long and hard about it. If you already have one of these deals, it's time for a chat with your tax advisor.

More on listed transactions here.

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So if we take this a step further and the employee cashes out the cash value life insurance policy in the 419 plan, I would think the proceeds would be taxed as ordinary income? the cash value of said life insurance policy cannot be rolled over into an IRA or another qualifed plan to avoid taxation. In general, is this correct?

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