What is IRC § 101(j)?

This bulletin briefly answers the following questions:

1. What is IRC § 101(j)?
   II. What must employers do to comply with IRC § 101(j)?
   III. What arrangements are subject to IRC § 101(j)?

Employer owned life insurance rules are critical for businesses that purchase life insurance policies on their employees. These rules, outlined under IRC 101(j), ensure that death benefits from employer-owned life insurance remain tax-free when proper notice, consent, and reporting requirements are followed. Understanding these rules helps employers structure policies like key-man insurance, stock redemption agreements, and executive compensation plans while staying compliant with IRS regulations.

 

1. WHAT IS IRC § 101(j)?

IRC § 101(j) addresses the tax-free nature of death benefits from employer-owned life insurance policies.

An employer-owned life insurance contract is a life insurance contract that is:

1. Owned by an employer (or a related party),
2. Under which the employer is directly or indirectly a beneficiary, and
3. That insures the life of an employee¹ of the employer on the policy issue date.

However, if the employee’s status fits one of the descriptions below and the employer complies with the requirements of IRC § 101(j), then the death benefit should not be subject to ordinary income tax rates.

If the insured employee meets certain criteria and the employer complies with IRC § 101(j), the death benefit remains tax-free, similar to benefits provided by life insurance to cover expenses for terminal illness or life insurance with a long-term care rider.

 

1. WHAT MUST EMPLOYERS DO TO COMPLY WITH IRC § 101(j)?

Effective Date: IRC § 101(j) applies to any employer-owned life insurance policies issued or materially changed after August 17, 2006.

There are two basic requirements: (a) Notice and Consent and (b) Employee Status.

a. Notice and Consent

Notice: The employer must provide written notification to the employee that the employer:

1. Intends to insure the employee’s life,
2. The maximum face amount for which the employee could be insured at the time the contract was issued, and
3. That the employer will be a beneficiary of any proceeds payable upon the death of the employee.

Consent: The employer must secure written consent from the employee prior to issue.

b. Employee Status

At the time of application, the insured must have one of the following titles in order for the death benefit to remain tax-free:

1. Director
2. Highly Compensated Employee
3. Highly Compensated Individual

In a recent Private Letter Ruling² (PLR), a business owner failed to secure formal written notice and consent, yet the IRS found that they had complied with IRC § 101(j)’s requirements.

In the PLR, the requesting party was a business where the stockholders were also employees. The taxpayer argued that the stockholder agreement and life insurance application – when taken together – met the notice and consent requirements. In fact, the stockholder’s agreement was in place prior to issuance of the policy and provided:

1. Notification of the business’s intention to insure the employees,
2. That the proceeds would be payable to the business, and
3. That the coverage could be continued after the employee’s termination.

Finally, the application provided the maximum face amount for which the insured could be covered at the time of issuance.

 

III. INFORMATIONAL REPORTING TO THE IRS

The Rule:

IRC § 60391 requires that the employer must report on Form 8925 the following information:

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 policyholder has a valid consent for each insured employee (or, if not all such consents are obtained, the number of insured employees for whom such consent was not obtained).

Due Date:

Form 8925 is due on the date the tax return is due, excluding extensions.

For example:

• A policy issued in 2011 to a corporation that is a calendar year taxpayer would be due March 15, 2012.
• A policy issued in 2011 to a partnership that is a calendar year taxpayer would be due April 15, 2012.

 

IV. WHAT ARRANGEMENTS ARE SUBJECT TO IRC § 101(j)?

As stated above, IRC § 101(j) covers employer-owned life insurance policies issued or materially changed any time after August 17, 2006.

Employer-owned life insurance contracts are life insurance contracts that are:

1. Owned by the employer or a related party,
2. Benefit the employer directly or indirectly, and
3. Ensure the life of an employee of the employer.

This definition is very broad; Congress casts a very wide net. Some examples of arrangements that fit this description are:

• Key-man policies
• Stock redemption buy-sell agreements
• Endorsement split dollar arrangements
• Family limited partnerships and LLCs
• Deferred compensation plans funded with employer-owned life insurance
• SERP plans funded with employer-owned life insurance
• 457 Plans funded with employer-owned life insurance

Remember that time-honored axiom:
“When in doubt, fill it out.”

 

¹ Under IRC § 101(j)(2), an “employee” is defined as either:

• An individual that serves as a director, a highly compensated employee, or a highly compensated individual at the time the policy is issued, or
• An individual that was employed by the employer at any time during the 12-month period before their death.

In addition, IRC § 101(j)(2) includes family members, trusts, and the estate of the insured employee as part of the term “employee” to the extent that the death benefits are used to purchase an equity interest in the employer.

If the employee does not fit one of these descriptions, then the death benefit will be subject to ordinary income taxes, regardless of whether the requirements of IRC § 101(j) are followed.

 

² See PLR 201217017. A PLR is issued in response to a taxpayer’s written request and is binding on the IRS only for the taxpayer who requested it; a PLR may not be relied on as precedent by other taxpayers.