Employer-Owned Life Insurance
By Dean Feenstra
Community Bank Advisor, 2007 Winter

On August 17, the Pension Protection Act of 2006 was signed into law by the president. Deep within the legislation, under the title “Pension-Related Revenue Provisions” is a section named, “Other Provisions” that will impact employer-owned life insurance policies issued after August 17, 2006. Buried within this section is a major landmine for what have been fairly routine uses of life insurance in many companies.

The major concern for Congress in passing this section was to eliminate the use of what was commonly known as “janitor insurance,” or the practice of companies taking out insurance policies on employees with or without their knowledge and collecting tax-free benefits upon the insured’s death, regardless of whether the employee had long left the employment of the business/owner.

Congress added a provision to Section 101 of the Internal Revenue Code (i.e., the section that provides for insurance proceeds to generally be paid to beneficiaries income-tax free). The new Section 101(j) now only excludes the total amount of premiums paid from gross income of an “applicable policyholder,” rather than the death benefit amount for “employer-owned life insurance” contracts.

Congress put in place certain exceptions for this provision to protect the tax-free benefit of life insurance for the majority of traditional succession business planning, but specific steps must be followed annually to qualify for this exception. The first exception is based on whether that employee is a “highly compensated individual” within the company or a shareholder. The second exception pertains to business succession planning and if the proceeds from the policy will be paid to the insured’s heirs by the due date of the tax year in which they are received. To meet the requirements of these exceptions, every applicable policyholder will be required to notify the insured on each policy and complete an annual filing requirement with the IRS. For further information, please consult your Plante & Moran tax advisor.