Section 101(j) Notice and Consent Requirements

Section 101(j) notice and consent requirements decide whether life insurance a company owns on an employee pays out income tax free. Before the policy is issued, the employer has to give the employee written notice and get written consent. It also has to fit one of the law's exceptions and report the coverage to the IRS each year on Form 8925. Miss the paperwork and the part of the death benefit above the premiums paid can be taxable to the company.

What Section 101(j) Is And When It Applies

Life insurance death benefits are generally income tax free. Section 101(j) of the Internal Revenue Code adds a condition when an employer owns the policy on an employee's life. The company pays the premiums, owns the contract, and collects the proceeds. In that setup, the tax-free treatment depends on following the notice and consent steps, and on fitting an exception.

Plenty of ordinary business coverage falls in this category. A few common examples:

• Key person coverage the company owns on a top producer or an owner-operator.
• A corporate-owned life insurance policy set up to informally fund a SERP or other deferred compensation promise.
• Phantom stock plans that the company informally funds with a policy.
• Company-owned policies inside some buy-sell and redemption structures.

Arrangements where the employee owns the policy are a different matter. A Section 162 executive bonus plan, for example, has the executive own the contract, so the company is not the owner. That is one real difference between the two designs, and it is worth weighing when you compare them with your advisors.

The Notice And Consent Steps

The timing matters more than anything else here. The steps generally have to happen before the policy is issued, not after it is in force and not at the first annual review.

What The Employer Tells The Employee

The written notice typically says three things. The employer intends to insure the employee's life. The maximum face amount the policy could carry. And the employer will be the owner and beneficiary of the policy.

What The Employee Agrees To

The employee gives written consent to being insured, and to the coverage continuing after they leave the company. Keep the signed form with the corporate records. If anyone ever questions the death benefit, that signed page is the proof.

Why Timing Trips People Up

We see this most when a company adds coverage in a hurry, or raises the amount years later. A new policy or a material change can call for fresh notice and consent. Ask your attorney or CPA how that applies before you change an existing policy.

The Exceptions That Can Keep A Death Benefit Tax Free

Notice and consent is one requirement. The policy also has to qualify under an exception. In general terms, the exceptions cover cases such as these:

• The insured was an employee at some point in the 12 months before death.
• The insured was a director or a highly compensated employee when the policy was issued.
• The proceeds go to the insured's family, a designated beneficiary, a trust, or the estate.
• The proceeds are used to buy an equity interest in the business from the insured's family or estate.

The exact definitions, such as who counts as highly compensated, are technical. This is a place for your attorney or CPA to read the statute against your facts. We would never want a business owner to rely on a summary in a blog post.

Form 8925 And Annual Reporting

The employer also reports its employer-owned life insurance each year on Form 8925. According to the IRS, the form asks for the number of employees covered by contracts issued after August 17, 2006, and the total amount of employer-owned coverage in force at year end. Your CPA is usually the person who files it with the company's return.

The practical takeaway is simple. Somebody at the company should own this task, and it should sit on the same calendar as the tax return.

What Happens If The Rules Are Missed

If a policy does not meet the notice and consent rules and no exception applies, the tax-free treatment of the death benefit can be lost. The portion of the proceeds above the premiums and other amounts the company paid may then be taxable to the company. On a large policy, that can mean a painful surprise at the exact moment the business is already dealing with a loss.

Premiums on this kind of coverage generally are not deductible either. So the tax benefit the company relies on is the income-tax-free death benefit, and 101(j) is what protects it.

A Simple Checklist Before You Buy Company-Owned Coverage

1. Decide who owns the policy. Company-owned brings 101(j) into play. Employee-owned arrangements are handled differently.
2. Prepare the notice and consent forms first. Have them ready and signed before the application goes in.
3. Confirm the exception. Your attorney or CPA checks which one fits the insured employee.
4. Put Form 8925 on the tax calendar. Name a person responsible each year.
5. Keep the records. Signed forms, the maximum face amount, and the policy date belong in the corporate file.
6. Revisit when things change. A new policy, a bigger face amount, or a new insured is a reason to check again.

This is part of the stewardship side of running a business. The coverage only does its job if the paperwork behind it holds up. Our strategies for business owners show how company-owned coverage fits with key person protection, buy-sell funding, and succession. If a permanent policy is part of the plan, our page on whole life insurance explains how it works.

If you already own company policies and aren't sure the forms were done, or you're planning new coverage, schedule a conversation with our team. We'll work alongside your attorney and CPA so the design and the paperwork match.