Corporate Owned Life Insurance (COLI)
“Corporate Owned Life Insurance” by Debbie Petrone, CPA, MTax, CGMA | Senior Manager – Tax
Corporate-owned life insurance (COLI) is a life insurance policy on an employee, owner, or director’s life that is owned by the employer, with benefits paid to the employer. Corporate- owned life insurance was originally intended to hedge against the financial cost of losing key employees due to an unexpected death, the cost of training replacements, or for the corporation’s obligation to redeem stock upon the death of an owner. This is often known as “key person” life insurance.
Under the Internal Revenue Service Code (IRC) that deals with life insurance benefits paid due to the death of the insured, death benefits paid are usually excluded from taxable income of the beneficiary. However, for employer-owned life insurance contracts issued after 8/17/2006, life insurance proceeds are excluded only if 1) the insured individual was an employee within 12 months before death, 2) the proceeds are paid to buy back an equity interest, or 3) the insured person was a “highly compensated” employee at the time the contract was issued.
Although not subject to regular corporate income tax, the proceeds may be subject to the 15% alternative minimum tax unless the small corporation exemption applies. A “small corporation” is defined as one having three-year average annual gross receipts not exceeding $5 million for its first year beginning after 1996, and having three-year average annual gross receipts not exceeding $7.5 million for any later year.
Another benefit of COLI is the tax treatment of “inside buildup.” Inside buildup refers to increases in the cash surrender value of the policies that result from investment earnings on premiums paid. Under current tax law, the inside buildup is not taxed.
Since death benefits are tax-free, the IRC prohibits the deduction of the premiums paid for life insurance when the premium payer is also the beneficiary of the death benefits. In addition, interest expense on loans taken against these life insurance policies to either pay for the premiums or to use for other business requirements is not deductible.
For life insurance contracts issued after August 17, 2006, certain written notice and requirements to the employees must be met. Form 8925 (Report of Employer-Owned Life Insurance) reports this information and is attached to the corporate return.
Because the corporation pays all of the premiums and receives all the benefits the individual actually insured does not receive any death benefits. Therefore, COLI is not an employee benefit and should not be confused with group life insurance benefits that employers provide to their employees.