When businesses consider life insurance for key employees, they are managing risk in the face of unforeseen changes. Key-person policies provide a measure of protection amid the disruption caused by the loss of an owner or other vital employee.
In the event of a settlement, death benefits are typically excluded from taxable income. Consequently, key-person policies are among the most effective risk management and succession planning strategies available. However, businesses must comply with several requirements when contracting for life insurance in order for their policies to qualify as tax-free.
Requirements to Consider
Failure to comply with these requirements put the proceeds of employer-owned life insurance in jeopardy of taxation.
- Section 101(j) of the Internal Revenue Code states companies must obtain consent from employees to be covered by life insurance policies in order for the proceeds of those contracts to qualify as excludable from taxable income.
- Specific details, including the amount of coverage, must also be provided to insured employees prior to the issuance of any policies.
- Basic policy terms are required to be reported with the company’s annual tax return on form 8925.
Without these measures in place, death benefits are classified as taxable income.
How We Can Help
If your business is considering purchasing life insurance for key personnel, the tax experts at Anderson Zurmuehlen can help you. We take steps to ensure the proceeds of these contracts qualify for the exclusion from taxation provided by section 101(j).
If your company is the policyholder on contracts covered by section 101(j), we can assist in reviewing your existing policies. Let us help to ensure your business is in compliance and has the required documentation.
Whether key person coverage is to be written to finance a future buyout, to fund deferred compensation, or to provide stability in a time of transition, compliance with 101(j) is essential for these policies to be tax-efficient when they are called on to perform. Contact the AZ Team today.
This article was written by Graham Black, CPA and Insurance Specialty Team member in our Missoula office.