The most common question asked about keyman (also known a key person) life insurance is whether the premiums are a tax-deductible expense. Per U.S. Code § 7702, the answer is, unfortunately, no. A business cannot deduct premiums paid on a company-owned life insurance policy where the company is a direct or indirect beneficiary under the policy. If the policy covers the life of an officer, an employee, or a person with a financial interest in the business and the employer purchases a policy to protect itself, the employer is deemed to be benefitting directly or indirectly.
As for the employee, premiums paid on a key person insurance policy are not taxable to the employee if they hold no incident of ownership in the policy. If the employee has the power to name the beneficiary, or if any of the proceeds benefit the employee, their family, or estate, the premiums are taxable to the insured employee as income.
Are death proceeds from Keyman insurance taxable?
The death proceeds of a life insurance contract are not taxable to the beneficiary. However, when the owner and beneficiary is a corporation, the Pension Protection Act of 2006 (PPA2006) spells out the provisions regarding the income tax treatment of life insurance death proceeds. It states that the death benefits paid to an employer is taxable to the extent it exceeds the employer’s premium payments unless certain requirements and exceptions are met for policies bought after August 17, 2006.
What are the requirements and exceptions for taxability on keyman insurance?
There are three notice and consent requirements:
- The company must notify the employee in writing that they intend to insure the employee’s life and the maximum face amount to be issued.
- The employer must inform the employee that they will be the policy beneficiary.
- The employee must give written consent before the policy is issued. The employee must also consent to the coverage continuing for up to 12 months after the employee terminates employment.
What tax forms are employers required to file for key person insurance?
Employers are also required to file IRC Form 8925 annually. The form lists the number of employees at the company and the number of employees covered under a key employee agreement. It also notes the total amount of insurance in force at the end of the year under these agreements.
It is recommended that notice be given and consent obtained at the time of application and a copy retained for audit. This communication is mandatory for any policy that falls within the scope of PPA2006. There is no provision for obtaining relief from these requirements. The cost of noncompliance is income taxation of the death benefit above premiums paid. Be on the lookout for this type of situation. They are plentiful.
Where can I find the experts on key person life insurance?
EMG Insurance Brokerage can help with keyman insurance planning for your client. You can find out more about life insurance and key person planning by calling EMG Insurance Brokerage. We know it is essential for advisors to access quality products, expert advice, and cost-effective solutions.
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