IRS Safe Harbor Rules Regarding Employer-Owned Life Insurance (EOLI) Contracts
Deadline: Sunday, June 14, 2009 at 11:59 PM.
The IRS has just issued a notice which relates to the taxability of insurance policies on employees payable to their employer. This could be for key man protection, to fund buy sells, to pay other obligations, or for other reasons. (This does not apply to insurance benefits directly payable to the employee’s own beneficiaries.) For employers affected by this notice there is a very short window of opportunity to take corrective action which may affect future taxability of the policy.
This alert only pertains to employers who meet all of the following conditions:
- The employer is the owner of a life insurance policy that insures the life of any employee, director, or other highly compensated employee or individual, and the policy was issued after August 17, 2006;
- The employer is the beneficiary for all or any part of the death benefit under the policy or policies; and,
- The insured employee did not receive a notice and sign a consent related to the company owned insurance policy with specific information required by the IRS before the policy was issued.
The Pension Protection Act of 2006 added §101(j) to the Internal Revenue Code regarding the taxation of death benefits payable under employer-owned life insurance (“EOLI”) contracts. The general rule under §101 of the Code is that death benefits payable under a life insurance contract paid by reason of the death of the insured are not included in the beneficiary’s gross income. However, new §101(j) makes life insurance taxable for EOLI contracts.
There is an exception to the §101(j) provision when contracts are based on: (1) the insured’s status as an employee during the 12 months before death, or as a director, a highly compensated employee, or a highly compensated individual when the contract is issued, or (2) the extent to which death benefits are paid to, or used to purchase an equity interest in the policyholder from, the insured’s family member, trust, or estate. These exceptions are only applicable if the notice and consent requirements under §101(j) are met (described below).
Safe Harbor Provision
The IRS has, within the past few weeks, released Notice 2009-48 which provides guidance in complying with §101(j). The Notice becomes effective June 15, 2009. The IRS has indicated that inadvertent failure to satisfy the notice and consent requirements can be remediated if certain conditions are met. These conditions are difficult to satisfy for EOLI contracts acquired in the past (a deadline limited to the tax return due date). In the Notice, however, the IRS indicated that it will not challenge a taxpayer who made a good faith effort to comply with the notice and consent provisions of §101(j) based on a reasonable interpretation of that provision, as long as that effort to comply occurs before June 15, 2009.
Immediate Action Before June 15, 2009
Employers that are owners and beneficiaries of EOLI policies on the life of an employee/director/highly compensated person should take the following actions:
All employees currently covered by an EOLI policy issued after August 17, 2006 should sign a written notice and consent that contains the following information:
- the employer intends to insure/or has insured the employee’s life;
- the maximum face amount for which the employee could be insured at the time the contract was issued;
- that such coverage may continue after the insured terminates employment; and,
- the employer will be a beneficiary of any proceeds payable upon the death of the employee.
See sample notice and consent form.
Finally, in order to show good faith, employers who are taking corrective action will need to simultaneously institute and maintain a “formal system for providing notice and securing consents from new employees.” This can be achieved either as an administrative directive, addition to an employee handbook, or as a resolution by a board of directors.
Going forward, companies must comply with these conditions prior to obtaining new EOLI policies.
Although we cannot know for certain if the IRS will recognize these attempts to comply with 101(j) as a “good faith” effort, it may provide a defense for those employers who did not issue a notice and consent prior to insuring an employee’s life. Please consult with your tax adviser or attorney on properly complying with IRC §101(j) including yearly reporting requirements using IRS Form 8925.
IRS Circular 230 Disclosure: To insure compliance with Treasury Regulations, we are required to inform you that any tax advice contained in this communication (including any attachments) was not intended or written by us to be used, and may not be used by you or anyone else, for the purpose of: (i) avoiding penalties imposed by the Internal Revenue Code; or (ii) promoting, marketing, or recommending to another party any tax-related matter addressed in this communication.