Up until fairly recently, the benefits from any life insurance policies owned by or related to a business were not subject to taxation. The laws changed, however, when it became more and more apparent that big businesses were taking out life insurance policies on some of their employees, without the employees even being aware that a policy existed.
Now, whether the employer-owned life insurance policy is being used to fund a buy-sell agreement or is being used to cover a key person or, more specifically, employee, the benefits received from such a policy can be taxed.
When the law was created, however, a few exceptions were worked in so that, in some instances, the benefits would remain tax-free if some specific criteria were met.
One such specification is that if an employer wishes to purchase an insurance policy for an employee, of which they are the beneficiary, they must notify and receive consent from that employee. The employee will have to sign a form stating that they know about the policy and are in agreement with their employer being the beneficiary.
Other specifications include things like the employee must be someone who is integral to the business in one way or another, meaning that the employer can’t just take out a life insurance policy on just any employee. What’s more is that the employee must be someone who worked at the company for more than a year before they passed away. Of course, if the life insurance policy is designed so that the insured’s loved ones, or rather heirs, are to receive the death benefits then the benefits will stay tax-free.
The only thing that can be confusing, from the standpoint of an employer, is that they won’t know if the policy’s death benefits will or will not be subject to taxation until the insured has in fact died. This means it may be more difficult for an employer to count on receiving a specific sum of money, if and when the insured dies.
If you are a business owner that is considering purchasing a policy for an employee or another business-related endeavor, contact a CPA or provider for more information. These are general rules and we are not giving tax advice please contact your tax professional for your individual situation.