Why Did I Get Taxed on My Employer-Owned Life Insurance Benefit?

The Pension Protection Act, enacted in 2006, impacted pension, 401(k) and other qualified retirement plans. The goal – to increase oversight of retirement plans and hold companies accountable for underfunded pension accounts. Hidden inside the Act is a provision regarding Employer-Owned Life Insurance (EOLI) that could cost your business hundreds of thousands of dollars.

EOLI is purchased by an employer to insure key employees, business partners, owners and even debtors. The employer is named as beneficiary of the policy in part or in whole. Two examples are:

• Key Person Insurance – Purchased to support the business if a critical employee passes away.
• Buy/Sell Agreements – Purchased to establish the succession plan of the business. This helps fund the buyout of a deceased partner’s interest in the business or buy some or all the shares of the company stock owned by the deceased.

EOLI keeps employers in control of their succession plan—and the benefits used to be tax-free!

Provision 101(j), hidden in the Act, mandates that death benefit proceeds of EOLI policies either executed or materially changed after August 17, 2006, be subject to ordinary income tax unless certain exemptions are met. Most notably:

1. The annual filing of IRS Form 8925
2. You must meet the IRS’s notice and consent requirements.
   1. Notice: Each insured employee must be notified in writing of the amount of insurance put in place and whether the employer will be a beneficiary of the policy.
   2. Consent: Each insured employee must provide written consent to being insured under the policy.

The notice and consent must be in place before the insurance policy is executed. 

3. The deceased had to be employed at any time during the 12-month period preceding death or, at the time the contract was issued, was a director or highly compensated employee or highly compensated individual.

Tax law is complex. To be certain your EOLI policies satisfy the IRS exemption rules and do not cost you hundreds of thousands of dollars, Marcum recommends a free professional review of your policies with our team of licensed professional accountants and financial advisors.

This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security/instrument, or to participate in any trading strategy.  This material is based on public information as of the specified date, and may be stale thereafter.  Marcum Wealth has no obligation to provide updated information on the securities or information mentioned herein.  This material should not be viewed as advice or recommendations with respect to asset allocation, any particular investment, or any tax advice.