Revenue Ruling 82-57: Tax on Shareholder Life Insurance

It is common for a closely held corporation to pay the premiums on a life insurance policy for a key shareholder-employee. This arrangement can provide financial security for the shareholder’s family and serve as a component of a business succession plan. While this action can seem straightforward, it can lead to specific tax outcomes for both the corporation and the shareholder. The tax treatment hinges on the policy’s ownership and beneficiary designations.

Conditions for Taxable Treatment

The tax implications of a corporation paying for a shareholder’s life insurance are clarified in guidance like Revenue Ruling 82-57. For the premium payments to be a taxable event for the shareholder, a specific set of conditions must be present. These conditions revolve around the ownership of the insurance policy and the flow of economic benefits. The Internal Revenue Service (IRS) looks at the substance of the transaction to determine who truly benefits from the premium payments.

A primary condition for this tax treatment is that the shareholder, or a beneficiary they designate, is the owner of the life insurance policy. This means the shareholder possesses the incidents of ownership, such as the right to change the beneficiary, surrender the policy for its cash value, or borrow against it. When the shareholder has this level of control, the premium payment by the corporation is viewed as a direct economic benefit to that individual.

The arrangement becomes taxable to the shareholder when the corporation, despite paying the premiums, is not a beneficiary of the policy. If the corporation has no right to the policy’s cash value and does not stand to receive any of the death benefit proceeds, it receives no direct benefit. The payment is therefore considered for the personal benefit of the shareholder.

Tax Consequences for the Shareholder

When a corporation pays life insurance premiums under the conditions described, the payments are treated as a constructive dividend to the shareholder. A constructive dividend is an economic benefit distributed by a corporation to a shareholder that is taxed as a dividend, even though it has not been formally declared. The principle is that the company has used its earnings to provide a personal benefit to the shareholder, which is functionally equivalent to a cash dividend.

The amount of the constructive dividend is equal to the total premium paid by the corporation for that tax year. This amount is considered income to the shareholder. The character of this income may be classified as a qualified dividend, provided certain holding period requirements are met for the underlying stock.

Qualified dividends are taxed at lower long-term capital gains rates, which can be 0%, 15%, or 20%, depending on the shareholder’s overall taxable income. This is often more favorable than the ordinary income tax rates that apply to wages or other non-qualified distributions.

Corporate and Shareholder Reporting Requirements

Proper reporting of the constructive dividend is a responsibility for both the corporation and the shareholder. The corporation must document the distribution by issuing Form 1099-DIV, “Dividends and Distributions,” to the shareholder. The total amount of the life insurance premiums paid for the year is reported in Box 1a of this form as “Total ordinary dividends.”

From the corporation’s perspective, these premium payments are not a deductible business expense. Because the payment creates a constructive dividend, it is treated as a distribution of after-tax profits to a shareholder. The corporation cannot claim a deduction for the premiums paid.

The shareholder who receives the Form 1099-DIV must report this dividend income on their personal income tax return, Form 1040, typically on Schedule B. It is the shareholder’s responsibility to accurately report this income, regardless of whether the corporation correctly issues the Form 1099-DIV. Failure to report the income can lead to underpayment penalties and interest charges.