As a business owner or employee benefits specialist, you’re most likely aware of the Pension Protection Act enacted in 2006. It increased oversight of retirement accounts and held businesses accountable for underfunded accounts. However, what many don’t know is that there is a provision within the Act that can cost businesses a large sum of money—and from time to time, we receive questions pertaining to this provision.
The intent of the Act was twofold;
The Act contains a provision that can result in a portion of the proceeds on an employer-owned life insurance (EOLI) contract to become taxable unless certain notice and consent requirements are met. EOLI are commonly used for key employees, owners, business partners, and sometimes even debtors.
Two examples where such policies are used:
Key Person Insurance provides coverage in the case that some member of staff critical to the business becomes deceased.
Buy or Sell Agreements are purchased as protection for part of a succession strategy—like in the case that a partner was to become deceased and need to be bought out. Such an event could entail the settlement of their interest in the business or the purchase of all shares of the company stock that they owned.
EOLI is essentially succession insurance, and it used to be that EOLI proceeds were tax-exempt.
Death benefit proceeds from EOLI policies either executed or materially changed after Aug. 17, 2006, are now subject to ordinary income tax unless certain exemptions are met. This is described in Provision 101(j) of the Act.
Exemption criteria include:
Also, the notice and consent steps must each be completed before the insurance policy is executed.
It’s important to be certain that your EOLI policies satisfy the IRS exemption rules. Otherwise, a portion of the proceeds could become taxable, potentially leaving the business owner without enough money to meet the needs for the purpose of having the life insurance.
You can contact Jared Weiskopf, CPA, Director, State and Local Tax Service Area Leader with concerns about EOLI or other corporate and partnership tax preparation, planning, and research.
Jared is a Director in the business tax service area and the Practice Leader in state and local taxation. Jared assists clients with corporate and partnership tax preparation and planning and research. Jared has provided public accounting services since 1997.More posts by Jared Weiskopf