Companies can also establish programs that allow the investment performance of the funding to loosely match the investment allocation selected by participants by utilizing variable life insurance products. Since the cash values are not subject to taxation during the accumulation period, the company does not need to pay the income tax costs incurred as under the Mutual Fund scenario. Therefore the company can achieve improved after-tax results.
In summary, the corporation pays non-deductible premiums, receives tax-deferred cash value accumulation, tax-free death benefit proceeds, and is able to book an asset to offset the account balance liability. The first is when an insured employee dies who worked for the employer at any time during the previous year. This rule prevents companies from continuing to hold policies indefinitely on former workers who are no longer employed by the company.
The other applies to directors and highly-compensated employees; any death benefit paid upon the death of this type of employee is also exempt from taxation. But money that is placed inside cash value policies by corporations grows tax-deferred just as for individuals. However, the issue of whether the insured's families or other beneficiaries of some types of COLI policies could receive tax-free death benefits has also been the subject of litigation.
Initially, the IRS disallowed the tax-free status of this benefit, it eventually recanted and permitted the policies to be paid without taxation to families and other heirs , although it stated that it felt that the death benefit in this case should be taxable according to its interpretation of the tax laws. For more information on this topic, consult your financial advisor.
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Your Money. Personal Finance. Your Practice. Popular Courses. Part Of. Employer Provided Insurance Definitions. Types of Employer Provided Insurance. Employer Provided Insurance Considerations. If a COLI is treated as a modified endowment contract, it does not receive the tax benefits that usually are afforded to life insurance contracts.
As a result, the corporation should try to avoid modified endowment contract status whenever possible. In general, the death benefits received from a COLI policy are exempt from federal income tax. However, Internal Revenue Code Section j , enacted as part of the Pension Protection Act of , limits the amount a corporation can receive as a tax-free death benefit in certain circumstances.
In general, unless an exception applies, the amount a corporation can exclude from income as a death benefit from a COLI policy cannot exceed the premiums and other amounts paid by the corporation under the policy. Any death benefit in excess of such amount is included in income. COLI is a savvy financial option that can be structured in many different ways to accomplish a wide variety of corporate objectives.
By working with an experienced employee benefits attorney to establish the COLI and related NQDC plan, the corporation can be sure to establish a customized plan that best meets its needs and also complies with applicable law. This article has been prepared for general information purposes and 1 does not create or constitute an attorney-client relationship, 2 is not intended as a solicitation, 3 is not intended to convey or constitute legal advice, and 4 is not a substitute for obtaining legal advice from a qualified attorney.
Always seek professional counsel prior to taking action. Enables the corporation to match assets to liabilities, thereby reducing or eliminating any cash flow issues when it is time for distributions to occur. Provides potentially tax-free buildup of cash value. Enables the corporation to recover all or part of the cost of the NQDC plan.
Deduction of Premiums Paid Premiums are not deductible when they are paid on any life insurance policy that covers any officer or employee of the corporation when the corporation is a direct or indirect beneficiary under the policy. Deduction of Interest Paid on Loans If the corporation borrows against the cash value that accumulates in a COLI, the corporation may be able to deduct the loan interest.
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