Broker Check

Dierdre Collins, MSFS, RFC
Tim Murphy, AIF, RFC

 

101J

As part of the Pension Protection Act, (PPA) IRC 101J requires employer-owned life insurance contracts to have a signed Notice and Consent and annually file of Form 8925 in order to qualify for exceptions to the general rule under this code section. Lack of compliance could significantly impact the tax consequences of the life insurance proceeds from these contracts.

Internal Revenue Code Section 101(j) created new Notice and Consent requirements that must be met before a policy is issued and requires annual filing of Form 8925 in order to qualify for any exceptions to the general rules under this code section as well as code section 6039I. The Company who owns the life insurance contracts must file Form 8925 on or before the due date of its next income tax return once the policy is “issued” and have a signed notice of consent prior to issuing the policy in order to qualify for any exceptions under 101(j)(2). Failure to comply with these provisions may mean that part of the death benefit may be taxed as ordinary income.

The law defines “employer-owned life insurance” broadly. It includes any policy if:
• The owner engages in a trade or business, and
• The owner (or a related party) is a beneficiary (direct or indirect), and
• The insured is an employee at the time of policy issue, and
• The insured is a U.S. citizen or resident.

The form deals only with the Notice and Consent requirement. Both the Notice and Consent and at least one of the four safe harbors specified in the new law must be in place to keep the death benefit income tax free.

Safe Harbor 1: Key Person
The insured is a key person at policy issue. This safe harbor (unlike the others) provides certainly at the time the policy is issued that the death benefit will continue to be income tax-free. The employer must keep good records. Possibly many years from now, when the employee dies, the employer may have to prove that the employee satisfied the key person rules when the policy was issued.
A key person for these purposes is someone who, at policy issue:
• Was a director of the employer.
• Was a 5% or greater owner in the year before policy issue.
• Received compensation of $95,000 or more (adjusted for inflation).
• Was one of the five highest paid officers.
• Was among the 35% highest paid employees.
You cannot know if the remaining safe harbors are available until the employee dies. Until then, the employer won’t know for sure if the death benefit is taxable or not taxable.

Safe Harbor 2: Current Employee
The insured was an employee any time in the 12-month period before death.

Safe Harbor 3: Death Benefit Paid to the Insured’s Heirs
• A member of the insured’s family (spouse, parents and grandparents,
children and grandchildren, brothers and sisters).
• An individual the insured named (other than the employer).
• A trust set up for anyone in those first two groups of people.
• The insured’s estate.
Although this may avoid income tax on the death benefit, it does create a split dollar arrangement. If the employer owns the policy and the person named as beneficiary is any of these people, the arrangement is, by definition, split dollar. The employee will be taxed on the economic benefit provided by the policy.

Safe Harbor 4: Buy-Sell Funds
Death benefits remain income tax-free if used to buy the insured’s interest in the employer (equity, capital or profits) from someone listed in Safe Harbor 3.

The Bottom Line

The requirements of Section 101(j) are cumbersome and unyielding. If all of the requisite notice and consent requirements are not in place prior to issuance of the policy then the proceeds are taxable.  We can help you with these new compliance requirements and reduce the chances of any unexpected tax consequences in the future.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. Harbor Strategies Group and LPL Financial do not provide tax advice or services.