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Taxes and Life Insurance

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Life Insurance

When you buy a life insurance policy, don’t overlook the tax angles. As the owner of a closely-held corporation, you may want your company to pay part or all of the premium costs for the policy. How will this affect your (and your company’s) tax picture?

The answer is, “It depends.” There are several different ways your company can help you buy life insurance protection and each has its own set of tax consequences. For example:

Executive Bonus Plan. With this arrangement, you take out the policy and name the beneficiary, but your company pays the premiums directly to the insurance company. As far as the IRS is concerned, this is treated the same way as if your company paid you a cash bonus. The premium payments are deductible by your company, taxable to you, and subject to payroll taxes.

Death-Benefit-Only Plan. Here, your company makes an agreement to pay your beneficiary a fixed sum if you die before retirement. To fund its obligation under the agreement, the company takes out a life insurance policy on your life and names itself as beneficiary. The company’s premium payments are not deductible. On your death, the company receives the policy’s death benefit tax-free and makes payments to your beneficiary on a tax deductible basis. However, the payments are taxable income to your beneficiary.

Split-Dollar Plan. This is a cost-sharing arrangement for a policy insuring your life. For example, your company may advance the premium payments and, at your death, recover an amount equal to the policy’s cash value. Your designated beneficiary gets the remaining proceeds, the insurance “at risk”. Or your company’s recovery may be limited to its cumulative premium payments. With this latter arrangement, known as “equity” split dollar, your beneficiary not only gets a portion of the death benefit, but you get access to a portion of the policy’s cash value during your lifetime.

Generally speaking, with a split-dollar plan, you owe tax each year on the “economic benefit” you receive from the company. .If you don’t have access to the policy’s cash value (i.e., it’s a non-equity policy), this economic benefit usually equals the cost of the insurance at risk (determined using IRS tables). If you have an equity split-dollar policy, you also owe taxes on the annual increase in the cash value you have access to. The economic benefit that is taxed to you is reduced by any portion of the premiums you pay out of your own pocket.

Special rules apply to certain equity split-dollar arrangements. Instead of providing you with an economic benefit, the company is treated as making a loan to you.

Term Insurance. Another option is having your company set up a group-term life insurance plan for its employees, including yourself. A special tax law provision exempts the first $50,000 of term coverage from tax. The plan generally cannot discriminate in favor of you and other key employees, either in terms of eligibility or coverage. However, your company can tie the amount of coverage into the amount of compensation each employee is paid.

We have just hit the high spots here. If you would like to discuss your life insurance plans in more detail, please contact us.

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