Corporate-owned life insurance a comprehensive guide

Corporate-owned life insurance is a type of life insurance policy that is owned and controlled by a corporation. This means that the corporation is the beneficiary of the policy, and the policy's proceeds are typically used to pay off company debts or finance business transactions.

The corporation may purchase a corporate-owned life insurance policy on the life of a key employee, such as a CEO or other high-ranking executive. This can help the company to secure a loan or pay off other business obligations in the event of the employee's death.

Corporate-owned life insurance can be used to fund a variety of business purposes, including executive bonuses, stock option exercises, and even the purchase of other companies. The policy can also be used to provide a tax-free source of funds for the company to use as it sees fit.

It's worth noting that corporate-owned life insurance is often used as a tool for estate planning, allowing the company to avoid paying taxes on the policy's proceeds.

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Corporate-owned life insurance, or COLI, refers to insurance policies taken out by companies on their employees, typically senior-level executives. The company is responsible for making the premium payments.

The company purchases a life insurance policy on an employee, and if the employee dies, the company receives the death benefit. The employee's family or heirs do not receive the death benefit.

COLI policies provide tax benefits to the owner, including tax-free death benefits and tax-deferred investment earnings on the policy's cash value. This tax treatment is a major reason companies use COLI policies.

Companies often purchase COLI policies on their owners, officers, directors, and debtors, in addition to senior-level executives.

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Tax implications are a crucial aspect of corporate-owned life insurance (COLI). The tax rules for COLI are complex and vary by state.

COLI policies can only be purchased on the highest-compensated third of employees, and the company must provide written notification to the insured employee before purchasing the policy. This notification must also be provided if the company is a partial or total beneficiary of the policy.

The death benefit from a COLI policy is usually tax-free, but there are some exceptions. If an insured employee dies who worked for the employer at any time during the previous year, the company is exempt from taxation. Additionally, death benefits paid upon the death of directors and highly-compensated employees are also exempt from taxation.

Here are some key tax implications to keep in mind:

The US tax law history surrounding life insurance benefits is quite interesting. The Internal Revenue Code excludes death benefits from taxable income, but this also means that premiums paid for life insurance by the employer are not deductible if the employer is also the beneficiary.

This exclusion has led to some creative tax planning opportunities. For example, in the 1980s, businesses exploited a loophole by buying life insurance on employees, allowing them to claim tax deductions on the premiums paid, even if the employer was also the beneficiary.

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The IRC prohibits the deduction of premiums paid for life insurance when the premium payor is also the beneficiary, which is why companies would often buy policies on low-level employees without their knowledge or consent. This practice, known as "dead peasant" insurance, was deemed a tax shelter by the IRS.

The IRS eventually limited the amount that could be borrowed against a policy to $50,000, but this led to the creation of broad-based leveraged COLI transactions that produced tax savings on interest deductions in excess of the actual cost to the employer. These transactions were often used by companies to exploit tax loopholes.

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The tax treatment of COLI policies is complex and varies from state to state. For federal income tax purposes, the death benefit from a life insurance policy is always tax-free for individual and group policies. However, for policies owned by corporations, there are specific requirements to retain tax-advantaged status.

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COLI policies can only be purchased on the highest-compensated third of employees, and employees must receive written notification of the company's intent to insure them and the amount of coverage. The employee must also receive written notification if the company is a partial or total beneficiary of the policy.

The death benefit paid upon the death of an insured employee who worked for the employer at any time during the previous year is exempt from taxation. Additionally, the death benefit paid upon the death of directors and highly-compensated employees is also exempt from taxation.

The IRS prohibits the deduction of premiums paid for life insurance when the premium payor is also the beneficiary of the death benefit. This applies to COLI policies, as the corporation is the direct beneficiary of the policy.

Here are some key points to keep in mind:

The corporation can deduct amounts paid to an employee under a NQDC plan that is informally funded by COLI. The corporation receives the deduction in the taxable year that its contribution is included in the employee's gross income.

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Corporate-owned life insurance (COLI) offers several benefits to companies, including providing psychological assurance to employees that their benefits will not be endangered by the corporation's cash flow demands. This is because COLI enables the corporation to match assets to liabilities, thereby reducing or eliminating any cash flow issues when it's time for distributions to occur.

COLI also provides potentially tax-free buildup of cash value, which can be a major advantage for companies. Additionally, it enables the corporation to recover all or part of the cost of the NQDC plan.

The tax benefits of COLI are significant, with death benefits being exempt from federal income tax. However, there are limits to this exemption, and companies must be aware of the rules and regulations surrounding COLI.

Here are some key benefits and risks of COLI:

Corporate-Owned Life Insurance has a history that dates back over 100 years. Its nickname "dead peasant" insurance originates in 19th century Russia, where feudal serfs were bought and sold as property by the rich.

Companies in America used COLI in the late 19th century to exploit a loophole in the Internal Revenue Code. This loophole allowed the owner of a life insurance policy to take out large loans from the cash value of the policy.

The IRS eventually limited this loophole to $50,000 of cash value per policy. However, the use of COLI as a tax shelter continued into the 1980s.

In the 1980s, many firms bought policies on large numbers of their lowest tier employees without their knowledge or consent. This allowed companies to collect tax deductions greater than the actual cost of the premiums paid.

The company would also collect the death benefit from the policy if the employee died, leaving little or nothing for the employee's family or estate. The 1990s saw the demise of much of this activity as the IRS cracked down on these practices in tax courts.

In 2006, Congress placed limitations on how companies could administer COLI policies. Some key changes include:

There are several risks associated with using corporate-owned life insurance (COLI) to informally fund a non-qualified deferred compensation (NQDC) plan. If the insurance company experiences severe financial difficulties, the corporation may be unable to access the policy's cash value to pay the plan benefits.

The disparity between estimated and actual earnings can leave the corporation with insufficient cash value to pay plan benefits when due. This is a concern, as the corporation should evaluate an insurance company's financial stability and earnings history before purchasing COLI.

The alternate minimum tax (AMT) is another risk to consider. If a corporate employer is the owner of a life insurance policy, the annual inside buildup (cash value) and death proceeds are among the factors that may subject the employer to the AMT.

If not properly structured, the use of a COLI policy to informally fund a NQDC plan can subject the plan to extensive Employee Retirement Income Security Act of 1974 (ERISA) provisions. These rules impose participation, vesting, funding, distribution, fiduciary, and reporting requirements on employer qualified plans and other funded plans.

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