EOLI Notice & Consent Rules Require Careful Planning to Assure Tax Free Death Benefit

IRC Section 101(j) was enacted as part of the Pension Protection Act of 2006. For Employer-Owned Life Insurance (EOLI) issued after August 17, 2006, the death proceeds of a life insurance policy above the policy cost basis will be income tax free only if certain Notice and Consent requirements are met.

 

IRS issued IRS Notice 2009-48 to clarify certain administrative requirements on which employers must take action to assure income tax free death proceeds in the future. This IRS notice remains an important guideline to follow when selling EOLI insurance for any business need. It applies to both permanent insurance and term insurance.

 

DEFINITION OF EMPLOYER OWNED LIFE INSURANCE (EOLI)

 

  •    •The Notice states that a policy is considered to be employer-owned only if it is owned by a legal entity engaged in a trade or business (i.e. C Corp, S Corp, LLC, Partnership, etc). A policy owned personally by a business owner on his own life is NOT an employer-owned policy.
  •    •A policy owned by a qualified retirement plan trust of an employer is NOT an employer-owned policy.
  •    •A policy that is personally owned by a business owner on the life of a co-owner (i.e. cross purchase buy sell) is NOT an employer-owned policy.
  •    •A policy owned by an employer to fund a stock redemption / entity type of buy sell agreement IS an employer-owned policy.
  •    •A policy owned by an employer to fund key person replacement IS an employer owned policy.
  •    •An employer-owned policy to fund a salary continuation / deferred compensation plan IS an employer-owned policy.
  •    •An employer-owned policy to fund an endorsement split dollar plan is considered to be employer-owned. Any death proceeds paid directly to a family member of the insured or a trust for the benefit of a family member of the insured is NOT considered employer-owned death proceeds.

 

APPLICATION OF SECTION 101(j)  “ISSUANCE OF THE CONTRACT” RULE

 

  •    •The Notice clarifies the “issuance of the contract” rule of Section 101(j) for purposes of determining whether the written notice and consent have been made in a timely manner. The policy is considered to be “issued” on the later of (1) application (2) the effective date of coverage or (3) the formal issuance of the contract.

 

SATISFYING NOTICE AND CONSENT REQUIREMENT

 

  •    •IRC Section 101(j) provides that notice and consent must be made in writing before the “issuance of the contract” (see above) to avoid income taxation of the death proceeds.
  •    •Notice and consent for EOLI is still required even if the insured is the owner-employee of a wholly-owned (100%) business entity.
  •    •No notice and consent is required for existing contracts where policy ownership has been transferred from an employee to the employer.
  •    •Inadvertent notice and consent failures can be corrected if made in a timely manner. The Notice states that IRS will not challenge a failure to originally satisfy notice and consent requirements if (1) the employer made a good faith notice and consent effort by maintaining a formal compliance system (2) the failure to satisfy the requirement was inadvertent and (3) the failure to satisfy notice and consent was discovered and corrected no later than the due date of the tax return of the employer for the year the policy was issued. An inadvertent notice and consent failure cannot be corrected after the employee has died.

 

SECTION 1035 EXCHANGES

 

  •    •IRC Section 101(j) notice and consent rules apply to contracts issued prior August 17, 2006 in a Section 1035 exchange for a contract issued after August 17, 2006 where a material increase in the death benefit has taken place. The contract is treated as a new contract issued after August 17, 2006. Technically, notice and consent is not required when the new policy in a Section 1035 exchange has the same death benefit or a lower death benefit than the original contract. However, it may be prudent to provide a notice and consent for all Section 1035 exchanges of EOLI policies as a matter of practice.

 

INFORMATION REPORTING AND FORM 8925

 

  •    •Employers owning 1 or more EOLI contracts issued after August 17, 2006 are required to file IRS Form 8925 annually with their regular tax return. By its own terms, IRS Notice 2009-48 is effective June 15, 2009 and states that the Service will not challenge a taxpayer who made a good faith effort to comply with Section 101(j) before June 15, 2009.

 

Contact your BSMG Life Advisor to discuss whether a new employer owned policy should be considered to correct any notice and consent defect on the existing policy. A new policy using the correct notice and consent procedure can assure that the death proceeds will remain income tax free. Click on this link for specimen “notice and consent” language that can be provided to the client’s attorney and CPA for final approval and implementation.

 

Call BSMG at 800-343-7772 today to discuss a case or feel free to reach out to Russ Towers, Vice President Business & Estate Planning directly.

 

Russell E. Towers, JD, CLU, ChFC
advanced sales
Vice President, Business & Estate Planning
russ@bsmg.net