This bulletin briefly answers the following questions:
I. What is IRC § 101(j)?
II. What must employers do to comply with IRC § 101(j)?
III. What information must be reported to the IRS?
IV. What arrangements are subject to IRC § 101(j)?
I. What is IRC § 101(j)?
For any employer-owned life insurance policies issued or materially changed after August 17, 2006, IRC § 101(j) puts conditions on the tax-free nature of death benefits from employer-owned life insurance policies. Failure to comply with the rules could cause the death benefit to become taxable income to the employer.
Under § 101(j)(3), the term “employer-owned life insurance contract” means a life insurance contract that:
(1) is owned by a person engaged in a trade or business, and under which such person (or a related person) is directly or indirectly a beneficiary under the contract.
(2) covers the life of an insured who is an employee of the applicable policyholder on the date the contract is issued.
II. What must employers do to comply with IRC § 101(j)?
To qualify for tax-free death benefits, an employer-owned life insurance policy must comply with two basic requirements:
(a) Notice and Consent
(b) Employee Status
Practice Note: The Notice and Consent requirements always apply to employer-owned life insurance, regardless of whether or not the employee status or ultimate beneficiary tests apply.
a. Notice and Consent
The notice and consent requirements of § 101(j)(4) are met if, before the issuance of the policy, the employee:
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is notified in writing that the applicable policyholder intends to insure the employee’s life and of the maximum face amount for which the employee could be insured at the time the contract was issued;
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provides written consent to being insured under the contract and that such coverage may continue after the insured terminates employment
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is informed in writing that an applicable policyholder will be a benefi ciary of any proceeds payable upon the death of the employee.
Solely for purposes of § 101(j)(2)(A) and (j)(4), an employer-owned life insurance contract is treated as “issued” on the later of (1) the date of application for coverage, (2) the effective date of coverage, or (3) the formal issuance of the contract. See Notice 2009-48 (A-4). In Private Letter Ruling 201217017, the IRS found that the stockholder agreement in place prior to the issuance of a certain life insurance policy contained certain provisions which, combined with the insureds signing the insurance applications on their lives, met the notice and consent requirements. Since this is not the case with most stockholder agreements, employers should not rely on this ruling as a way to cover themselves for failure to execute the proper Notice and Consent documents. Insurance carriers generally provide § 101(j)-compliant forms, and it is best to use the standard form.
b. Employee Status or Ultimate Beneficiary
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An employee at any time during the 12-month period before death.
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Alternatively, the business may retain a policy more than 12 months after the termination of employee status and still receive a tax-free death benefit if at the time the policy was issued, the insured qualified as one of the following:
Employee Status: For death benefits to be tax-free, the insured had to be:
(i) Director
(ii) Highly Compensated Employee within the meaning of IRC § 414(q)
(iii) Highly Compensated Individual within the meaning of IRC § 105(h)(5).
IRC § 105(h)(5) includes the five highest paid officers, 10% shareholders, and the top 25% of employees by compensation (with certain exclusions). § 101(j)(2) modifi es this last requirement to include the 35% highest earning employees.
Ultimate Beneficiary: To the extent that the death benefit is paid to a member of the insured’s family, another individual who is not an affiliate of the business, a trust for the benefit of the foregoing, or the estate of the insured, the death benefits are not income-taxable. Likewise, the death benefit is tax-free to the extent it is used to purchase an equity interest in the business from one of these beneficiaries.
III. What information must be reported to the IRS?
The Rule: IRC § 6039I requires the employer to report on Form 8925 the following information:
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The number of employees of the applicable policyholder at the end of the year;
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The number of such employees insured under such contracts at the end of the year;
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The total amount of insurance in force at the end of the year under such contracts;
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The name, address, and taxpayer identification number of the applicable policyholder and the type of business in which the policyholder is engaged;
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That the policyholder has a valid consent for each insured employee (or, if not all such consents are obtained, the number of insured employees for whom such consent was not obtained).
Due Date: Form 8925 is due on the date the tax return is due excluding extensions. For example, a policy issued in 2014 to a corporation that is a calendar year taxpayer would be due March 15, 2015; and, a policy issued in 2014 to a partnership that is a calendar year taxpayer would be due April 15, 2015.
Failure to file Form 8925 is generally considered a “failure to file” and is not, by itself, a condition which would trigger § 101(j).
IV. What arrangements are subject to IRC § 101(j)?
The definition of “employer-owned life insurance policies” outlined above is very broad; Congress casts a very wide net. Some examples of arrangements that fi t this description are:
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Key person policies
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Stock redemption buy-sell agreements
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Endorsement split-dollar arrangements
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Family limited partnerships and LLCs
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Deferred compensation and SERP plans informally funded with employer-owned life insurance