By Mike Martinez, CLU, ChFC
Director, Doeren Mayhew Insurance Group

Is your employer-owned life insurance policy in compliance with Section 101(j)?

If not, it could mean that any death proceeds paid to your company from an employer-owned life insurance (EOLI) policy could be considered taxable income to your company.

Internal Revenue Code Section 101(j) applies to policies issued after August 17, 2006 (or issued pursuant to a 1035 exchange with material increases to the death benefit or material changes to the policy) for which a business is the owner of the policy, the business is directly or indirectly the beneficiary, and an employee is the insured.

The general rule is that death benefits paid from a life insurance policy subject to Section 101(j) are taxable when received. Obviously, not the intended preferred outcome when acquiring a life insurance policy.

The good news is that there are some exceptions as well as procedural steps to follow in order to not only be in compliance with the regulation, but also remain compliant going forward and thereby protect this valuable income tax-favored benefit.

If you are not sure whether Sections 101(j) and Sections 60391 apply to a particular life insurance policy or are not sure what must be done to ensure death benefits are received tax-free, continue reading.

Qualifying Exceptions

  1. The insured is a director or highly compensated employee, or
  2. The employee was employed by the business no later than 12 months prior to death, or
  3. Death benefits are paid to employee’s heirs, or
  4. Death benefits are used to purchase an interest in the business

In addition to qualifying for one of the exceptions above, the employer must provide the insured employee with written notice stating the business intends to:

  • Obtain a life insurance policy on the employee, may continue the policy after the employee terminates employment, will be the beneficiary of the life insurance policy, and disclose the maximum amount of life insurance coverage the business will obtain on the employee.
  • The insured employee will need to consent in writing to all the disclosures in the notice prior to the issuance of the policy.

Lastly, in order to avoid taxation of the death benefits, the business must report to the Internal Revenue Service (on Form 8925) on an annual basis certain pertinent information regarding the business’ EOLI policies.

Indemnifying your company against the financial loss caused by the death of a key person is vitally important. The insurance advisors at Doeren Mayhew Insurance Group will review your key person coverage to ensure your EOLI policies qualify for and remain a tax-favored benefit to your business. We look forward to the opportunity to review your policies. Contact us to get started.