IRS Sets Out Limits for Employer-Owned Life Insurance Expense

In the  notice , IRS defined “employer-owned life insurance contract” and presented guidance in a question-and-answer format on exceptions to the provisions, notice and consent requirements, a transition rule, reporting requirements, and the effective date of the guidance.  

The Notice provides a definition of “employer-owned life insurance contract” as 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, and (2) covers the life of an insured who is an employee of the applicable policyholder (generally the person who owns the contract) on the date the contract is issued.

IRS said the deduction-from-gross-income limits under Section 101(j)(1) do not apply if:

• the insured person was an employee at any time during the 12 months before his or her death or
• if the insured person was a director, a highly compensated employee or highly compensated individual when the contract was issued.

The Notice goes on to note that specifically, “Section 101(j)(1) limits do not apply to any amount received upon the death of an insured employee “to the extent the amount is paid to or used to purchase an equity interest from a family member of the insured, an individual who is a designated beneficiary, a trust established for the benefit of a family member or designated beneficiary, or the estate of the insured.”   However, in order to qualify for that exception, the amount must be paid or used by the due date of the tax return, including extensions, for the taxable year of the policyholder in which the policyholder is treated as receiving a death benefit under the life insurance contract.

Among the questions (and answers) provided in the notice:

• Can a contract be an employer-owned life insurance contract if it is owned not by a person engaged in a trade or business, but by a related person who is not engaged in a trade or business? (the short answer; no.).
• Can a contract be an employer-owned life insurance contract if it is subject to a split dollar arrangement? (short answer, yes).
• Is a contract an employer-owned life insurance contract if it is owned by a partnership or sole proprietorship that is engaged in a trade or business; the partnership or sole proprietorship is directly or indirectly a beneficiary under the contract; and, the contract covers the life of an insured who is an employee with respect to the trade or business on the date the contract is issued? (short answer, yes).
• For purposes of §101(j), is the term "employee" limited to common law employees? (short answer, no)
• Is notice and consent required of an owner-employee of a wholly-owned corporation? (short answer, yes)
• Is notice and consent required with regard to an existing life insurance contract that an employee irrevocably transfers to an employer? (short answer, no)
• May a single consent apply to more than one employer-owned life insurance contract? (short answer, yes)
• May the notice and consent requirements of § 101(j)(4) be satisfied electronically? (short answer, yes, subject to certain conditions)
• Are the notice and consent requirements of §101(j)(4) met by advising an employee that the face amount of life insurance may be "the maximum face amount for which the employee could be insured" at the time the contract is issued? (short answer, no)

Expanded answers to these questions, and additional questions are available online at http://www.irs.ustreas.gov/pub/irs-drop/n-09-48.pdf 

The IRS Notice is effective June 15, 2009.   According to the notice, the IRS will not challenge a taxpayer who "made a good faith effort to comply with § 101(j) based on a reasonable interpretation of that provision before that date."

The principal author of this Notice is Linda K. Boyd of the Office of Associate Chief Counsel (Financial Institutions & Products). For further information regarding this Notice, contract Linda K. Boyd at (202) 622-3970 (not a toll-free call).