During the nearly 25 years I have practiced law in the area of Estate Planning and Business Succession Planning, No “technical” tax change has personally caused me more dismay or made less sense than Congress’ most recent blunt instrument approach to “fixing” a perceived abuse of life insurance policies. New IRC §101(j), added by the Pension Protection Act in 2006, is ostensibly directed toward major public corporations’ practice of insuring virtually any employee (so-called “janitor insurance”). It has, I believe, unfortunately unfair and far-reaching consequences for the 1000's of closely held business companies in the United States.
Ownership of life insurance on key participants has long been an important tool for funding Buy-Sell obligations. In many cases, it is the only way a business can insure that upon the untimely death of a participant, his or her family will receive fair payment for the decedent’s interest in the business.
Like life insurance proceeds in the hands of individuals, the proceeds of such business-owned policies have always been income tax free under §101(a) of the IRC. Now, Congress has set a major trap for the unwary!
New Section 101(j) reverses the time-honored rule that such proceeds are income tax free and replaces it, instead, with the presumption that the proceeds will be income taxable, unless the employer meets certain exceptions and new requirements created by the section.
Under §101(j), in order for such proceeds to be received by the business free of income tax, the insured employee must be (1) employed by the business during the 12 month period prior to death, or (2) a director or (3) a “highly compensated employee,” (4) or used to purchase an equity interest from the decedent’s family or estate.
It may seem that this will not be a problem in most cases. However, the section additionally imposes Notice and Consent requirements, which require that the employer give written notice to the employee of the intent to obtain insurance, of the maximum face amount of the policy, and that the employer will be the owner and beneficiary of the policy--and which require that the employee sign a written consent to such insurance, before the issuance of the insurance contract. It does not appear that the IRS would accept a confirmation of such intent at any time after the contract has been issued. This seems to go far beyond addressing the problem it was intended to address.
When advising your clients regarding the purchase of “Buy-Sell” insurance policies, it will be important that all the advisors are aware of this issue and that the written consent and notice requirements are followed and well-documented.
This Newsletter is intended to be informational, only and does not constitute legal advice. If you have questions, concerns or comments, please contact me at: email@example.com, or by Telephone at 989-652-9923.