IRS Sets Out Limits for Employer-Owned Life Insurance Expense

The Internal Revenue Service (IRS) has, in Notice 2009-48, set limits on expenses for employer-owned life insurance that policyholders can deduct from their gross income.

In the notice, the IRS defined “employer-owned life insurance contract” and presented guidance in a question-and-answer format on exceptions to the provisions, notice and consent requirements, a transition rule, reporting requirements, and the effective date of the guidance.

The Notice provides a definition of “employer-owned life insurance contract’ as a life insurance contract that (1) is owned by a person engaged in a trade or business, and under which such person (or a related person) is directly or indirectly a beneficiary under the contract, and (2) covers the life of an insured who is an employee of the applicable policyholder (generally the person who owns the contract) on the date the contract is issued.

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IRS said the deduction-from-gross-income limits under Section 101(j)(1) do not apply if:

  • the insured person was an employee at any time during the 12 months before his or her death or
  • if the insured person was a director, a highly compensated employee or highly compensated individual when the contract was issued.

The Notice goes on to note that specifically, “Section 101(j)(1) limits do not apply to any amount received upon the death of an insured employee “to the extent the amount is paid to or used to purchase an equity interest from a family member of the insured, an individual who is a designated beneficiary, a trust established for the benefit of a family member or designated beneficiary, or the estate of the insured.’ However, in order to qualify for that exception, the amount must be paid or used by the due date of the tax return, including extensions, for the taxable year of the policyholder in which the policyholder is treated as receiving a death benefit under the life insurance contract.

Questions and Answers

Among the questions (and answers) provided in the notice:

  • Can a contract be an employer-owned life insurance contract if it is owned not by a person engaged in a trade or business, but by a related person who is not engaged in a trade or business? (the short answer; no.).
  • Can a contract be an employer-owned life insurance contract if it is subject to a split dollar arrangement? (short answer, yes).
  • Is a contract an employer-owned life insurance contract if it is owned by a partnership or sole proprietorship that is engaged in a trade or business; the partnership or sole proprietorship is directly or indirectly a beneficiary under the contract; and, the contract covers the life of an insured who is an employee with respect to the trade or business on the date the contract is issued? (short answer, yes).
  • For purposes of §101(j), is the term “employee” limited to common law employees? (short answer, no)
  • Is notice and consent required of an owner-employee of a wholly-owned corporation? (short answer, yes)
  • Is notice and consent required with regard to an existing life insurance contract that an employee irrevocably transfers to an employer? (short answer, no)
  • May a single consent apply to more than one employer-owned life insurance contract? (short answer, yes)
  • May the notice and consent requirements of § 101(j)(4) be satisfied electronically? (short answer, yes, subject to certain conditions)
  • Are the notice and consent requirements of §101(j)(4) met by advising an employee that the face amount of life insurance may be “the maximum face amount for which the employee could be insured“ at the time the contract is issued? (short answer, no)

Expanded answers to these questions, and additional questions are available online at http://www.irs.ustreas.gov/pub/irs-drop/n-09-48.pdf

The IRS Notice is effective June 15, 2009. According to the notice, the IRS will not challenge a taxpayer who “made a good faith effort to comply with § 101(j) based on a reasonable interpretation of that provision before that date.’

The principal author of this Notice is Linda K. Boyd of the Office of Associate Chief Counsel (Financial Institutions & Products). For further information regarding this Notice, contract Linda K. Boyd at (202) 622-3970.

IMHO: “End″ Points?

Several years back, after a day of meetings in Manhattan, I caught the train home.
I wound up on one of those “milk run’ trains that makes every stop along the way—and, trust me, there are a lot of stops between Manhattan and “home.’ To make a long story short, I decided to take a short nap…and woke up just as the train was pulling away from my station.
It wasn’t a big “miss,’ mind you. But that 15-minute nap cost me about two hours of time and a lot of aggravation…and, of course, it could have been a lot worse.
It seems that many things long taken for granted in our business are today being subjected to a whole new level of scrutiny, including the very efficacy of the 401(k). The most recent “target’ is, of course, target-date funds—and the examiners no less than the U.S. Senate, the Securities and Exchange Commission, and the Department of Labor (see “More Details Released about Target-Date Hearing” and “Senate Committee Takes Aim at Target-Date Funds) .
That examination is not necessarily a bad thing, of course. The reality is that these offerings have quickly become a de facto investment solution for the nation’s prime retirement savings alternative, and in the past couple of years received nothing less than the official sanction of the DoL itself (at the instigation of Congress via the Pension Protection Act). That said, these solutions have benefited hugely from their simplicity. What is sold is the concept: professional money management, monitored and rebalanced over time. And to some extent, that is also what is bought.
What’s Being Bought
However, IMHO, there is something else that is being bought, if only implicitly—the ability to not have to worry about saving for retirement (1).
With target-date solutions, and more specifically with target-date solutions as part of an automatic-enrollment strategy, we’ve been able to set aside many of the messages we once viewed as essential to participant/investor education. We no longer have to teach participants about the importance of asset allocation, the wisdom of “not putting all your eggs in one basket’ (quite the contrary, in fact), nor the need to keep an eye on your investments and to regularly rebalance. The message today is, tell us your birth date and “we’ll take care of all that.’ And so we have.
There are two problems with that approach as I see it. The first is one of message—I think we may well have given a fair number of participants a message, if only subliminally, that they no longer need to worry about their retirement savings because we’ve attended to their retirement investing2. That, of course, can be easily remedied—an effort that will doubtless be encouraged by the sustained market downturn and its impact on investors of all kinds. Still, for many, I’m sure the recent downturn has left them feeling the way I did as I watched the train pull away from my station.
The second problem is perhaps more insidious—and it is that “problem’ that I suspect regulators will be trying to deal with next month. It is quite simply that, at the moment, we have lots of target-date funds on the market with nearly identical names—but very different philosophies. And, like it or not, in an age where we’re selling “don’t worry about it’— somebody has to.
Personally and professionally, I would hate to see us “fix’ the problem by complicating the simplicity of a target-date choice. On the other hand, how can we continue to hold out a dozen different versions of the “right’ asset allocation mix for a particular point in time without doing a better job of articulating that those differences exist, and explaining what those differences are?

What’s a Target-Date?

I’d start by explaining “target-date.’ Once upon a time, the target-date was widely understood as being your retirement date, but more specifically, it was the date on which you would stop accumulating money for retirement and start drawing it down; and, yes, in most cases that was focused on the year in which the investor turned 65. Of course, these days, the definition of retirement is less precise; it’s not always 65, for one thing, and a growing number may leave a full-time career for a while and renter the workforce a couple of years later. Those kinds of changes, if not always in the control of the individual participant, are at least things that he or she is in a position to be aware of.
But for any number of target-date solution providers, the target-date in their fund family name is only a mile marker along the way, rather than the destination itself. They have developed strategies that ostensibly take the participant investor not only beyond that retirement date, but, in some cases, to the date upon which they leave this mortal coil.
Now, there’s nothing wrong with that as a strategy if the participant-investor understands that and appreciates what that means. On the other hand, if they think—as I am sure many do—that the target-date is the end, the point at which they are “done’— well, they could well wind up, as some surely have, being taken beyond their intended station—with no easy way to get back.

1Now, I realize as well as anyone that you don’t invest your way to retirement security. But we also know that most participants tend to concentrate on the things they can’t influence (picking investment funds, market trends, the availability of a company match) rather than their rate of saving—ironically, the one thing that they can, subject to certain economic realities, control.
2While automatic-enrollment programs are clearly an effective means of getting workers to save for retirement, I’ve worried in this column previously that it might also insulate them from these issues (see IMHO: “Expert’ Opinions).

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