SUCCESSIONS

Devil in the Details: Avoiding Income Tax on Death Benefit of Corporate Owned Life Insurance

Closely held businesses often acquire life insurance on key employees to provide extra cash for the transition upon that employee’s unanticipated death or to fund the redemption of stock for succession planning. These businesses often assume that the death benefit will be free of income tax when received. However, the Internal Revenue Code provides that life insurance proceeds of a corporate owned life insurance policy are taxable income to the corporate owner unless certain IRS requirements are met.

Section 101(j) of the Internal Revenue Code provides that proceeds of corporate-owned life insurance policies are generally taxable income to the corporation. Fortunately, however, there is a simple, but essential income tax return requirement that makes the proceeds non-taxable.

Section 101(j) of the Internal Revenue Code provides that proceeds of corporate-owned life insurance policies are generally taxable income to the corporation. Fortunately, however, there is a simple, but essential income tax return requirement that makes the proceeds non-taxable. IRS Form 8925 must be filed at the end of the year the policy is issued. Form 8925 is a fairly simple informational form filed with the corporation’s income tax return. In addition to the Form, the corporation must give written notice of the policy and coverage amount to the insured employee, and obtain his or her consent to the insurance arrangement, as well as to the fact that the corporation is to be named as beneficiary. The notice and consent documentation must be obtained before the life insurance policy is issued.

Failure to comply with section 101(j) results in policy proceeds paid on the death of the insured employee being taxable to the extent that proceeds exceed premiums paid and other costs incurred in obtaining the insurance. Late filing is not a solution. In order to avoid income tax on proceeds, corporate policyholders may be forced to consider re-issuing the policy if Form 8925 was not properly filed or the notice and consent were not properly issued and documented.