Proceeds received from a life insurance policy generally are excluded from income. Further, the cost of premiums for life insurance, annuity or endowment contract are not deductible, if the payer is directly or indirectly a beneficiary under the contract. However, the amount excluded from gross income with respect to an employer-owned life insurance contract cannot exceed the premiums and other amounts paid by the policyholder for the policy. Thus, the excess death benefit is included in the employer’s income.

Fortunately, there is an exception that applies to contracts issued for any individual who was an employee at any time during the 12 months before their death, or who, at the time the contract was issued, was a director, highly-compensated employee or highly-compensated individual. The IRS has issued final regulations detailing the information reporting requirements for policyholders that own employer-owned life insurance contracts.

An employer-owned insurance contract is one in which the employer owns a policy and is a beneficiary under a contract that covers the life of an employee in the employer’s trade or business. To be entitled to full exemption of the death benefit from gross income with regard to such contracts issued after August 17, 2006, the employer-policyholder must meet notice and consent requirements. Specifically, before the issuance of the contract, the employee:

1. must be notified in writing that the employer intends to insure the life of the employee and the maximum face amount of the policy for which the employee can be insured;
2. must provide written consent to being insured under the contract, and that such coverage may continue after the insured terminates employment; and
3. must be informed in writing that the employer will be a beneficiary of any proceeds payable upon the death of the employee.

In addition, the employer is required to keep records and to file an annual report to the IRS on Form 8925, Report of Employer-Owned Life Insurance Contracts by attaching it to the policyholder’s income tax return for each tax year ending after November 13, 2007. The report must include the following information:

1. the number of employees at the end of the tax year;
2. the number of employees insured under an employer-owned life insurance contract at the end of the year;
3. the total amount of insurance in force at the end of the year under such contracts;
4. the employer’s name, address, and taxpayer identification number and the type of business engaged in; and
5. a statement that the policyholder has a valid consent from each insured employee, or, if not all such consents are obtained, the number of insured employees for whom such consent was not obtained.

If you wish to take advantage of the death benefit exclusion, it is important that you meet all the applicable requirements. Somerset can assist with preparing the documentation and filing the correct IRS form. Please post a comment to this blog or contact us direct with any questions you have regarding employer-owned life insurance policies.