IRC 101(j) Requirements for Employer-Owned Life Insurance
Navigate the tax rules for employer-owned life insurance. This guide explains how IRC 101(j) connects employee status to the tax treatment of policy proceeds.
Internal Revenue Code (IRC) Section 101(j) governs the tax treatment of proceeds from employer-owned life insurance (EOLI) policies. Enacted as part of the Pension Protection Act of 2006, this law established a framework where specific conditions must be met for death benefits to be received by an employer tax-free.
The rules apply to life insurance contracts issued after August 17, 2006, and to pre-existing policies that undergo a material change. The law introduced procedural requirements and specific exceptions that businesses must follow to avoid having death benefits included in their taxable income.
The General Rule of Taxability for EOLI Contracts
Under Section 101(j), the default rule is that death benefits from an EOLI contract are included in the employer’s gross income. This treatment reverses the previous standard under IRC Section 101(a) where proceeds were tax-free. The taxable amount is the death benefit received minus the sum of premiums and other amounts paid by the policyholder for the contract.
An “employer-owned life insurance contract” is a policy owned by a business where the business is a direct or indirect beneficiary. The policy must cover an individual who is an employee on the date the contract is issued. The term “applicable policyholder” refers to the business entity that owns the policy.
This definition includes policies used to fund non-qualified deferred compensation plans, key person insurance, and entity-purchase buy-sell agreements. The rule applies to all business structures, including corporations, partnerships, and sole proprietorships.
Exceptions Permitting Tax-Free Proceeds
Section 101(j) provides several exceptions that allow death benefit proceeds to be received by the employer income tax-free. These exceptions are based on the insured employee’s status within the company or on how the proceeds are used.
Key Employee Status
An exception applies based on the insured’s status when the contract was issued. Death proceeds can be excluded from the employer’s taxable income if the insured individual was a director of the company. The proceeds can also be received tax-free if the insured was a “highly compensated employee” as defined under IRC Section 414(q). For 2025, an employee meets this standard if they were a 5-percent owner during 2024 or 2025, or if they received compensation of more than $155,000 from the business in 2024.
Recent Employee Status
Another exception allows for tax-free receipt of proceeds if the insured was an employee at any point within the 12 months ending on their date of death. This provision applies regardless of the employee’s role or compensation level. It ensures that if an employee passes away shortly after leaving the company, the proceeds are not automatically subject to income tax.
Payments to Heirs
An exception also applies based on the recipient of the death benefit. If the proceeds are paid to a member of the insured’s family, their designated beneficiary, or a trust established for their benefit, the amount is not taxed to the employer. This also applies if the proceeds are used to purchase an equity interest in the company from the insured’s family, beneficiary, or estate, which can facilitate business succession planning.
Notice and Consent Requirements
To qualify for the exceptions permitting tax-free death benefits, an employer must meet notice and consent requirements before the life insurance contract is issued. Failure to complete these steps invalidates the exceptions, causing the proceeds to become taxable.
Before the policy is issued, the employer must provide written notice to the employee. This notice must state the employer’s intent to insure the employee’s life, disclose the maximum face amount of the insurance, and inform the employee that the employer will be the beneficiary.
The employer must also obtain the employee’s written consent to be insured. This consent must acknowledge that the coverage may continue even after the employee’s employment has terminated. Both the notice and consent must be completed before the policy is issued.
Annual Reporting Obligations
Compliance also includes annual reporting requirements. Employers with one or more EOLI contracts must file Form 8925, “Report of Employer-Owned Life Insurance Contracts,” with their federal income tax return each year the contracts are owned.
On Form 8925, the employer must report the number of employees at year-end and the number of those insured under EOLI contracts. The employer must also disclose the total amount of insurance in force on these employees. Finally, the business must attest that it has valid consent on file for each insured employee, confirming the notice and consent requirements have been met.