by Julie Ngo
Exceptions
Assuming that all of the “Notice and Consent” requirements have first been met, the proceeds from an EOLI contract paid because of the death of an employee will be received income-tax free if any of the following exceptions applies:
• Recent employment: If the insured was an employee any time during the 12-month period before death.
• Executives: If, at the time the policy was issued, the insured was a director, or a highly compensated employee, as defined under the rules relating to qualified retirement plans, determined without regard to the election regarding the top-paid 20 percent of employees, or a highly compensated individual as defined under the rules relating to self-insured medical reimbursement plans, determined by substituting the highest-paid 35% of employees for the highest-paid 25% of employees.
• Amounts paid to the insured’s heirs: Death proceeds are excluded from income to the extent that an amount is (1) paid to a family member¹ of the insured, to an individual who is the designated beneficiary of the insured under the contract (other than the applicable policyholder), to a trust established for the benefit of any such family member or designated beneficiary, or to the estate of the insured; or (2) is used to purchase an equity (or partnership capital or profits) interest in the applicable policyholder from such a family member, beneficiary, trust or estate.
Transition Rule and IRC Sec. 1035 Exchanges
IRC Sec 101(j) generally applies to EOLI contracts issued after August 17, 2006. There is an exception for policies issued after that date which were acquired in an IRC Sec. 1035 exchange for a contract issued on or before that date. Any material change in the death benefit or other material change can result in the contract being treated as a new contract, and thus subject to IRC Sec. 101(j).²
Annual Reporting Requirement
IRC Sec. 60391 imposes both record keeping and annual reporting requirements on any employer that owns one or more EOLI contracts. IRS Form 8925 is used to make the required annual report.
Seek Professional Guidance
Given the complexities involved, and because the dollar cost of not meeting the requirements of IRC Sec. 101(j) can be high, competent professional guidance is strongly recommended.
¹ A family member, as defined in IRC Sec. 267 (c)(4) includes the individual’s brothers and sisters, spouse, ancestors, and lineal descendants.
² See IRS Notice 2009-48, 14, for a description of changes to existing EOLI contracts which would not be considered “material” changes.
