IRS releases guidance on COLI
Tax Facts | National Underwriter Company
The IRS has released guidance in the form of questions and answers concerning the treatment of employer-owned life insurance contracts.
New rules affecting "employer-owned life insurance contracts" (typically referred to as "COLI") were enacted under PPA 2006. Section 101(j)(1) provides the general rule, which states that in the case of an employer-owned life insurance contract, the amount excluded from gross income of an applicable policyholder under Section 101(a)(1) must not exceed an amount equal to the sum of the premiums and other amounts paid by the policyholder for the contract. However, Section 101(j)(2) provides exceptions to the general rule if certain notice and consent requirements are met. The exceptions are based on either: (1) the insured's status as an employee at any time during the 12-month period before the insured's death or as a director, a highly compensated employee, or highly compensated individual at the time the contract is issued; or (2) the extent to which death benefits are paid to (or used to purchase an equity interest in the applicable policyholder from) a family member, trust, or estate of the insured employee. Section 6039I provides that every applicable policyholder that owns one or more employer-owned life insurance contract issued after August 17, 2006, must file a return in the prescribed time and manner setting forth specific information for each year the contracts are owned. In order to satisfy this requirement, a taxpayer must file Form 8925.
The Q&As address numerous topics, including: (1) the definition of "employer-owned life insurance contract"; (2) exceptions to the application of the general rule of Section 101(j)(1); (3) satisfaction of the notice and consent requirements; (4) the transition rule and Section 1035 exchanges; and (5) information reporting under Section 6039I and Form 8925. A few topics are discussed below:
Employer-owned life insurance contract defined
According to the Service, a contract qualifies as an "employer-owned life insurance contract" only if it is owned by a person engaged in a trade or business and is otherwise described in Section 101(j)(3). Thus, the Service stated, any of the following types of contracts can generally qualify as an "employer-owned life insurance contract" if the contract is otherwise described in Section 101(j)(3):
- A contract owned by a grantor trust (such as a rabbit trust), the assets of which are treated as assets of a grantor that is engaged in a trade or business.
- A split-dollar arrangement, if the contract is owned by a person engaged in a trade or business. But the general rule (of Section 101(j)(1)) does not apply to the extent any amount received as a death benefit is paid to (1) a family member of the insured, (2) an individual who is a designated beneficiary, or (3) a trust established for the benefit of a family member or designated beneficiary.
- A contract owned by a partnership engaged in a trade or business (but not a sole proprietor).
The Service reiterated that even if an exception is otherwise satisfied, the notice and consent requirements of Section 101(j)(4) must still be met in order for the general rule not to apply. According to the Service, the notice and consent requirements are met if, before the issuance of the policy, the employee:
(1) is notified in writing that the applicable policyholder intends to insure the employee's life and of the maximum face amount for which the employee could be insured at the time the contract was issued;
(2) provides written consent to being insured under the contract and that such coverage may continue after the insured terminates employment; and
(3) is informed in writing that an applicable policyholder will be a beneficiary of any proceeds payable upon the death of the employee.
Notice 2009-48, 2009-24 IRB 1085
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