Notice and consent requirements for employer-owned life insurance

An Employer-Owned Life Insurance (EOLI) contract is defined as a life insurance policy issued after August 17, 2006, that:

Unless an exception applies, an applicable policyholder must include in gross income the death benefits received under an EOLI contract that exceed the total premiums and other amounts paid by the policyholder for the contract.

Two exceptions

1. The first depends on the insured’s status as an employee.

The exception will apply if the insured under the contract was:

2. The second exception occurs when the death benefits are either:

These exceptions apply only if the notice and consent requirements are met before the issuance of an EOLI contract.

As a general rule, whenever a business entity owns a life insurance policy (including wholly owned corporations and sole proprietorships), specifically in these business succession strategies:

The IRS stated that life insurance policies issued in cross purchase arrangements generally will not qualify as EOLI contracts for purposes of IRC.

To fit within any exception to EOLI taxation, policyholders must satisfy certain notice and consent requirements prior to issuance of the EOLI contract. The IRS issued the following guidance regarding compliance with the notice and consent requirements:

Notice

The employee must receive written notification that the applicable policyholder intends to insure the employee’s life; reasonably expects to purchase a specified maximum amount of life insurance (stated either in dollars or as a multiple of salary) on the employee during the employee’s tenure; and will be a beneficiary of any proceeds payable upon the death of the employee.

Consent

The employee must provide written consent to being the insured and to the continuation of coverage after termination of the insured’s employment. The contract must be issued:

While the IRS presumes that an employee will receive a separate form for notice and consent, a recent private letter ruling by the IRS held that a separate document was not required where the totality of the applicable policyholder’s documentation in connection with the EOLI contract evidenced that all the notice and consent requirements were met prior to contract issuance (specifically a buy-sell agreement and a life insurance application, both executed by the insured employee prior to issuance of the contract, which together contained all the required notice and consent information).

For existing EOLI contracts

An employer may be able to show evidence of notice and consent without separate documentation if it can demonstrate that all required notice and consent information was included in one or more documents that were provided to and/or executed by the insured employee prior to the contract’s issuance.

For newly issued contracts

Obtaining a separately executed notice and consent form from the insured employee will more easily and clearly document compliance.

In addition, EOLI policyholders must file Form 8925 with their annual federal tax returns for each year that an EOLI contract is owned to report certain information regarding EOLI contracts, including the number of employees insured, the total insurance held under EOLI contracts and the number of non-consenting insured employees (if any). The policyholder must also keep whatever records may be necessary to evidence compliance.

The only situations in which the IRS will not challenge inadvertent failures to satisfy the Notice and Consent requirements are when:

• The applicable policyholder made a good faith effort to satisfy the notice and consent requirements (e.g., maintains a formal system for notice and consent for new employees);
• The failure to satisfy the requirements was inadvertent; and
• The failure to obtain the notice and consent was discovered and corrected by the due date of the tax return for the taxable year in which the EOLI contract was issued (failure to obtain consent cannot be corrected if the insured employee has died).

Otherwise, removing the “taint” of an improperly issued EOLI contract often involves 1) canceling the existing policy and issuing a new one, or 2) affecting a material increase in the policy death benefit or other material change in the contract. The notice and consent requirements must be satisfied prior to the issuance of a new policy or a material change in an existing policy.