Taxation in Key Man Life Insurance

Thinking of buying a key man life insurance policy for key persons in your organization? You need to be really careful otherwise your death benefit might be open to taxation. In the recent years, many significant amendments have come into place that can affect your death benefits to a great extent.

Before you procure a key man life insurance policy, it is pertinent to understand and abide by the IRS requirements. This will help you avoid unnecessary taxation from your death benefit and you will be able to save your hard-earned money.

U.S. President, George Bush on August 17, 2006 inked regulations that included provisions which have wide-ranging insinuations for key man and other company owned life insurance procured purchased after August 17, 2006.

According to this proposed legislation, death claims for life insurance policies bought after this specified date call for taxation. However, if some terms are met with, then it may be released tax-free.

The Pension Protection Act of 2006 that consists of COLI Best Practices Act has certain conditions which have connotations for key man life insurance and other type of employer owned insurance bought after August 17, 2006. According to this law, all the cases wherein the employer has some or full rights of a life policy, irrespective of the purpose of the life insurance policy, has to abide by the under mentioned terms and conditions so as to evade tax on death benefits.

  1. The key person or employee should be informed beforehand that he is being insured by the company. He should also be divulged the total amount that he is being insured for. The key person should also be notified that the employer/company is the key man insurance beneficiary of the entire or partial death benefit.
  2. The key employee should give in writing that he is aware that his employer is buying a key man life insurance for him.
  3. Key man life insurance policy should pertain to loss of profits that are likely to come upon the company in case of death of a key person. However, if the policy relates to a loan, it will not be regarded as key man life insurance. In such a scenario death benefits of key man life insurance may invite key man taxation.

Consult Inspector of Taxes

Every case is unique in its own way. So, if you have any doubts about taxation on key man life insurance, you should seek advice from Inspector of Taxes. He will be able to tell you whether your key man life insurance policy will be tax-free or not.

Generally, Whole life insurance policies are not tax free. Key man life insurance should either be yearly or short-term. Also, premiums of life insurance policies wherein a director holds 5% or more shares in an organization are tax deductible.

If death benefits from key man life insurance call for taxation, the tax amount will be based on the kind of policy. For instance, payment for key man insurance will be treated as a trading receipt and will thus attract corporation tax. This is apposite in this case because death benefits from key man life insurance will be used to make up for the loss of revenues, and this would be taxable.