Employer-Owned Life Insurance Policies: Tax Treatment & Reporting Requirements

In the past, money received through a life insurance contract, paid by reason of the death of the insured, were generally not included in gross income for federal tax purposes. However, the Pension Protection Act of 2006 enacted important statutory changes to the general rule for employer-owned life insurance contracts, stating that death benefits received in excess of premiums paid are now generally taxable based on the provisions of IRC Sec. 101(j).

Nonetheless, several broad exceptions allowing tax-free treatment are provided, including life insurance policies owned by an employer in which:

• The insured was an employee at any time during the 12-month period prior to death
• The insured was a director or highly compensated employee at issuance of the policy
• The death benefits are paid to a member of the family, an individual beneficiary, or the trust or estate of the insured
• The death benefits are used to purchase an ownership or profits interest in the employer-policyholder

However, to qualify for the tax-free death benefits, notice and consent provisions are required before the policy is issued or substantially modified. Specifically, prior to the issuance of the contract, the employee must:

• Receive written notice that the employer intends to insure the employee’s life, and the maximum face amount of the insurance;
• Provide written consent to being insured, noting that coverage may continue after the insured terminates employment; and
• Be informed in writing that the policyholder will be a beneficiary of proceeds payable upon the death of the employee.

For policies acquired after the legislation was enacted August 17, 2006, information must be disclosed annually to the IRS through tax Form 8925, consisting of the following for each year the contracts are owned:

• The number of employees of the “applicable policyholder” at the end of the year
• The number of those employees insured under “employer-owned life insurance contracts” at the end of the year
• The amount of insurance in force at the end of the year under those contracts
• The name, address and taxpayer identification number of the “applicable policyholder” and the type of the business in which the policyholder is engaged
• A statement that the “applicable policyholder” has a valid consent for each insured employee (or, if all required consents are not obtained, the number of insured employees for whom consent was not obtained)

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