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Life Insurance Proceeds From Business-Owned Policies Might Not Be Tax-Free—New Rules Apply to Policies Issued After August 16, 2006

It is often important for a business to own insurance that will provide funds to help replace a "key person" who dies unexpectedly. In other instances, a business may obtain a policy to provide funds to purchase an equity interest from the decedent's estate. Some businesses were obtaining life insurance policies on almost all their employees and maintained these policies long after the employee left. As a consequence, Congress made some drastic changes in the Pension Protection Act of 2006 for policies issued on employees after August 17, 2006. One outcome of this bill was the creation of Form 8925, which is required to be filed for certain employer-owned life insurance contracts for tax years ending after November 13, 2008. This form is for employers who are the owner and beneficiary of life insurance policies on the life of an employee.

Normally, life insurance proceeds are not subject to income tax. In the Pension Protection Act of 2006, Congress changed the rules with respect to life insurance proceeds received in excess of premiums paid. Thus the excess of life insurance proceeds over premiums and other amounts paid are taxable to the business. However, for "employer-owned life insurance contracts" issued after August 17, 2006 for which one of the following are met, the aforementioned excess is not taxable.

1. The employee consented to the employer's purchase of the insurance prior to the issuance of the policy (this includes officers and highly compensated employees of the employer). Please note that the employee must have either been employed at any time during the 12-month period before the insured's death or a director or highly compensated employee at the time the policy is issued.
2. The proceeds are made to a member(s) of the family or a trust established for the benefit of a member(s) of the family of the insured.
3. The proceeds are used to purchase an equity (capital or profits) interest in the employer from the family or trust noted above.

Consequently, Form 8925 must be completed with respect to any employer-owned life insurance contracts issued after August 17, 2006. The form is not required to be filed for contracts issued before August 18, 2006. However, a contract will be considered as new if there is a material increase in the death benefit or other material change is made to the contract. This form is required to be included with the employer's income tax return.

The following information is required to be reported on Form 8925:

1. The number of employees of the applicable policyholder at the end of the year;
2. The number of such employees insured under such contracts at the end of the year;
3. The total amount of insurance in force at the end of the year under such contracts;
4. The name, address and taxpayer identification number of the applicable policyholder and the type of business in which the policyholder is engaged; and
5. That the applicable policyholder has valid consent for each insured employee (or, if all such consents are not obtained, the number of insured employees for whom such consent was not obtained)

If you have obtained new life insurance on employees of your business and have not filed Form 8925 with your income tax return, please contact us for assistance in complying with this requirement. Again, please note that even if the employee is an owner of the business, the above rules are applicable.

For further information please contact Kira Wheat at 312-980-3331 or Mike Calahan at 312-980-2996.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.