Many practitioners are not familiar with the specific ins and outs of owning life insurance inside of a company, even though the rules changed back in 2006. If your clients need the protection of key person insurance, you will need to help them meet the requirements of 101(j). Compliance with IRC Section 101(j) is necessary to protect the income tax-free treatment of death proceeds from employer-owned life insurance.
What is IRC Section 101(j)?
The general rule is that employer-owned life insurance death proceeds are taxable, to the extent they exceed cost basis, unless the requirements of Section 101(j) are met.
The overall framework of IRC Section 101(j) imposes certain requirements, which if met, will generally allow death benefits of employer-owned life insurance to be received income tax-free.
How does it work?
If the general rule of Section 101(j) is that employer-owned life insurance death proceeds are taxable, then how do death proceeds that are payable to an employer, from employer-owned contracts, qualify as tax-free under the general rule of IRC Section 101(a)?
The first condition is that the employer must comply with the notice and consent requirement. In general, the insured will need to sign a written notice and consent form prior to the policy issue date. The other major condition is that at least one of the specific exceptions to the general rule must be met. These exceptions are based on either the insured’s status with an employer, or the fact that death proceeds are payable to, or for the benefit of, the insured’s heirs, including for the purchase of an insured’s equity interest in the employer.
Additionally, annually a form 8925 must be filed with the company’s tax returns. This form details the life insurance that is owned on covered employees.
More Resources on IRC Section 101(j)
To learn more about complying with the 101(j) rules and working with life insurance in a company, click the buttons below to access our video explanation and comprehensive advisor guide: