Employer-Owned Life Insurance

The tax-free nature of a life insurance policy’s death benefits has always been a major advantage for those receiving the death benefits. This may no longer be the case with the introduction of IRC Section 101(j).

Employer-owned life insurance policies issued after August 17, 2006, may now be subject to tax unless certain exceptions apply. One of the most often missed exception is collectively known as Notice and Consent and must be completed prior to the insurance contract being issued in order to qualify for the tax-free treatment.

The Notice and Consent requires the following:

1)  The employer must provide written notification to the employee that the employer 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 is issued.

2)  Employers must obtain written consent from employees being insured under the contract and advise them that such coverage may continue after the insured terminates employment.

3)  Employees must be informed in writing that the employer will be the beneficiary of any proceeds payable upon the death of the employee.

Unfortunately, the insurance providers cannot always be relied upon to communicate these requirements to the policy holder. Carriers have approached these requirements in very different ways, some requiring the Notice and Consent forms in all cases, some for certain states or product while others do not communicate the requirement at all. This is unfortunate as the severity of the penalty is extreme, i.e., taxation of the death benefit which would normally be tax-free.

Another unfortunate issue arises if the Notice and Consent is missed, there is no fix. There may be a bright light under Notice 2009-48 which allows errant policies to come into compliance and preserve the tax-free nature of the death benefit. The failure must be discovered and corrected no later than the due date of the tax return for the taxable year of the applicable policy holder in which the contract was issued.

In addition IRC Section 60391 also requires the employer to file Form 8925 with the employer’s tax return. Accountants need to be aware of this requirement, but unfortunately many are not because the employer has forgotten to tell the accountant about the purchase of the insurance.

If you have missed the filing then there may be time for corrective action based on Notice 2009-48. This is the time to consult with your accountant and insurance expert.