Key Change in Tax-Free Requirements for Business/Employer Owned Life Insurance Proceeds

Vital to a company’s success, key employees’ lives are often insured by their employers. Employers should be aware of new laws that may nullify the tax-free benefit of these policies.

Business/employer owned life insurance policies have new requirements that must be met if the proceeds are to be received generally tax-free. First, the employee must receive proper notice and give his or her consent before the policy is issued – an insurance application is not sufficient.

The second requirement can be met in several ways. If the employee was either “highly compensated” when the policy was purchased or was simply employed by the company in the 12 months before death, the tax-free requirement can be satisfied. Another way to meet the second requirement is to purchase the employee’s equity interest in the business from a specific seller (i.e. family member) with the policy’s proceeds. Paying the proceeds to a designated beneficiary (other than the employer) will also meet the requirement.

These requirements must be met by all life insurance policies issued after Aug. 17, 2006. According to Doug Friedman, senior partner at Friedman & Downey, if you are aware an affected policy does not meet these requirements, the only option currently is to reissue the policy. For all future policies, Friedman recommends simply making note to comply with the statute in order for proceeds to be generally free from income tax.

Friedman & Downey is an independent law firm secured for council by S.S. Nesbitt & Co. For more information on this and other regulations, contact your S.S. Nesbitt agent.