The notice and consent checklist for employer-owned life insurance

When a company buys life insurance on an employee and expects to be paid, a federal rule decides whether the death benefit stays income tax-free. The rule, IRC section 101(j), asks for a written notice and a written consent before the policy is issued, and it asks the company to report on its tax return each year. A company that skips a step can find that only the premiums it paid come back tax-free and the rest is taxable income. This checklist lays out the steps in the order they happen, with the reason for each.

It is general information about how the rule works, not tax advice. The details, including who counts as an eligible insured, are where a CPA or tax attorney earns the fee.

Does the rule apply to your policy?

The notice and consent rules apply to what the tax code calls an employer-owned life insurance contract. In plain terms, that is a life insurance policy that:

• is owned by a business (a corporation, partnership, sole proprietorship or other trade or business),
• covers someone who is an employee of that business when the policy is issued, and
• names the business, directly or indirectly, as a beneficiary of the death benefit.

The rule was added for contracts issued after August 17, 2006, and it is explained in the glossary entry on section 101(j) notice and consent. Typical situations that fall inside it:

• A key person policy on a founder or top salesperson. See key person life insurance.
• A company-owned policy that funds a buy-sell agreement among owner-employees. See funding a buy-sell agreement with life insurance.
• Corporate-owned life insurance on executives to help fund deferred pay or benefits. See corporate- and bank-owned life insurance.
• Some split-dollar arrangements where the employer owns the policy. See split-dollar life insurance.

Situations that usually fall outside it: a policy you own personally on your own life, a policy that a trust owns for your family, and an ordinary group term benefit where the employee names the beneficiary. If you are not sure which side your arrangement is on, assume the rule applies and ask a professional to confirm.

Checklist item 1. Write down who owns the policy, who is the beneficiary and who is insured. If the business is the owner or a beneficiary and the insured is an employee, continue with the rest of this list.

Group 1: Decide whether the insured is an eligible insured

The law does not allow a company to insure just anyone and keep the full tax benefit. It builds exceptions around the insured's relationship to the company. Without going into the definitions, here is how the structure works.

The death benefit is taxed as described in the next section unless the notice and consent steps were done and one of the following is true:

• the insured was an employee at some point in the 12 months before death, or
• when the policy was issued, the insured was a director, a highly compensated employee, or a highly compensated individual.

A separate set of exceptions concerns where the money goes: proceeds paid to the insured's family members, designated beneficiary, a trust or the estate, or used to buy an ownership interest from them are treated differently. How these categories combine, and how the tax code defines "highly compensated," are matters for your tax professional. The definitions come from other sections of the code and use compensation thresholds that change.

This is why the rule is aimed at the broad-based COLI programs of the 2000s, in which companies insured many rank-and-file workers, sometimes without telling them. A small firm insuring its owner or a few executives is in a very different position, but it must still follow the paperwork.

Checklist item 2. Ask your CPA to confirm in writing which exception covers each insured person: employee within 12 months, director, highly compensated employee or individual, or the family and equity-purchase category. Record the answer with the policy file.

Checklist item 3. If the person you plan to insure is not clearly in one of those categories (for example, a newly hired mid-level worker), stop and reconsider before applying. The business reason also has to hold up under the insurable interest: who can buy life insurance on whom rules of your state.

Group 2: Prepare the written notice

The notice comes first, and it must be written. Under the statute, the employee must be told in writing, before the policy is issued, that:

1. the employer intends to insure the employee's life,
2. the maximum face amount for which the employee could be insured at the time the policy is issued, and
3. the employer will be a beneficiary of any proceeds.

Why each item matters: the employee cannot give informed consent to something they have not been told about. Telling them the maximum face amount sets a ceiling the company cannot silently exceed. Telling them who the beneficiary is prevents the misunderstanding that the policy is a perk for the family.

Checklist item 4. Draft a notice that states, in plain language, all three points. Name the employee, the company and the maximum face amount.

Checklist item 5. Choose the maximum amount carefully. If you list $500,000 and later want $750,000, that increase may require new paperwork. A common practice is to state a maximum high enough to cover reasonable future needs, but a figure far above the real purpose can look like overreach and may raise questions on reading. Discuss it with your advisers.

Checklist item 6. Deliver the notice to the employee in a way you can prove: signed receipt, dated email acknowledgment or a signed copy at a meeting. Give them time to read it; a document handed over at the application desk and signed on the spot invites later disputes.

Group 3: Obtain the written consent

The consent is a separate step from the notice. The employee must agree in writing to being insured and to the coverage continuing after they leave the company, if that is what the company intends. In practice, one document usually combines the notice and consent, with the employee's signature and date at the bottom.

What a good consent form does:

• states the consent to being insured as an individual,
• says the coverage may continue after the employee's employment ends,
• repeats the maximum face amount and that the employer will be a beneficiary,
• is dated, signed by the employee and kept by the employer.

Checklist item 7. Make sure the consent is signed and dated before the policy is issued. A signature added after issue, or a form backdated to match, does not satisfy the rule and creates more trouble than it solves. If you find the form was missed, tell your tax adviser; do not fix it with a new date.

Checklist item 8. Confirm that the consent covers continuation after termination of employment. This matters because the "employee within 12 months before death" exception expires, and the company will often keep a key person or buy-sell policy for years after someone leaves. If the consent was silent on that point, ask a professional whether it can be cured prospectively.

Checklist item 9. If the insured is a minor, lacks capacity or will not sign, the company cannot cure the problem on its own. Do not apply.

Group 4: Application and issue

The tax code looks at the date of issue, and the paperwork has to be in place before that date.

Checklist item 10. Do not submit the application until the notice and consent are signed. If the insurer's application allows you to tick a box about employer ownership, answer it accurately. The life insurer may have its own employer-owned policy form, and some require the company to certify that notice and consent were obtained.

Checklist item 11. Match the application to the notice: owner, beneficiary and amount. The face amount actually issued must not exceed the maximum named in the notice.

Checklist item 12. Keep the policy, application, notice and consent together. For a company-owned policy with a collateral assignment of life insurance to a lender, tell the lender where the file is.

Group 5: Annual reporting

Employers that own these contracts report to the IRS each year, with their tax return, on Form 8925 (Report of Employer-Owned Life Insurance Contracts). According to the IRS, the form reports the number of employees the business has, the number covered by employer-owned contracts issued after August 17, 2006, and the total amount of employer-owned life insurance in force at year end (IRS, About Form 8925). Read the current form instructions for the other items it asks about, including how the employer confirms its consent records.

Checklist item 13. Calendar a yearly task to gather the policy count and face amount at year end and give them to whoever prepares the return.

Checklist item 14. Include every covered employee, not just the ones you remember. A policy that someone bought years ago and no one has looked at is still reportable.

Checklist item 15. Keep Form 8925 copies with the policy file. When a claim is filed, the paper trail is the evidence that the business followed the rule.

Group 6: Changes after issue

The rules can come back into play when something about the policy changes.

• Increasing the death benefit. A material increase or other material change can be treated as a new contract, which would call for a new notice and consent. Ask a tax professional what counts as material in your case.
• Replacing the policy. Moving coverage to a new insurer or policy, including through a section 1035 exchange, generally means a new contract and a new set of paperwork.
• Changing the owner or beneficiary. A change in who owns the policy or who receives proceeds can affect employer-owned status. Review before you sign the change form, and consider the the transfer-for-value rule as well.
• Adding a new insured. Each additional employee needs their own notice and consent before their policy is issued.

Checklist item 16. Make a rule inside the company: before any change request goes to the insurer, someone checks it against this list.

Group 7: When the insured leaves, retires or dies

On departure. The insured has no right to the policy simply because they leave. If the company keeps it, the consent that continues after employment is what supports the arrangement. If the company drops it, the options include letting term coverage lapse or offering the policy to the person; the tax effects of a sale or transfer should be reviewed first.

At death. The company files the claim as the owner and beneficiary. The usual claim documents are listed in documents you need for a life insurance claim. Have the notice, consent and your Form 8925 copies ready. The insurer reports and pays according to its own procedures; your tax adviser decides how to treat the proceeds on the return.

Checklist item 17. When a key employee leaves, add a line to the offboarding list: decide what to do with the policy and confirm the consent form is on file.

What is at stake if a step is skipped

The consequence is tax, not forfeiture of the policy. If the rule applies and no exception saves the transaction, the portion of the death benefit that exceeds the premiums and other amounts the employer paid is included in the employer's income. An illustration, with invented numbers:

Say a small company pays $4,000 a year for 12 years, a total of $48,000, on a $400,000 policy on an employee for whom no valid consent was obtained and no exception applies. At the employee's death the company receives $400,000. The tax-free amount is limited to the $48,000 paid, so $400,000 minus $48,000 equals $352,000 would be included in income. The tax owed then depends on the company's tax situation, which is the point of asking a CPA before the application, not after the claim.

The illustration is only a rough picture of the rule's reach. It does not state any company's actual tax rate.

What employees should check before they sign

Employees are on the other side of this paperwork. A few questions are worth asking.

• What is the maximum face amount, and why that figure?
• Does the form say coverage can continue after I leave the company?
• Will any part of the proceeds go to my family, or is the company the only beneficiary?
• Is the company paying for any coverage for me personally? If so, that is separate from this policy; compare it with what your family needs, and see business owner policy ownership: personal, business-owned or partner-owned for how ownership choices affect the plan.
• Where will the signed notice be kept, and may I have a copy?

If the application includes health questions, ask who will see the answers. Federal law does not generally forbid an employer from insuring an employee who has validly consented, though some states add their own insurable interest or consent rules. Your state insurance department can tell you what applies where you live.

A one-page version to keep

For quick reference, the order of operations is:

1. Confirm the policy is employer-owned (business owner or beneficiary, employee insured).
2. Confirm the insured fits an eligible category with your CPA.
3. Draft the notice: intent to insure, maximum face amount, employer as beneficiary.
4. Obtain a signed, dated consent including continuation after employment.
5. Apply and issue only after steps 3 and 4.
6. Match the policy to the notice.
7. Report on Form 8925 with the yearly return.
8. Revisit for increases, replacements, owner changes and new insureds.
9. At departure or death, check the file before acting.

Key takeaways

• IRC section 101(j) applies when a business owns a policy on an employee and is a beneficiary; it asks for written notice and signed consent before the policy is issued.
• The notice states the intent to insure, the maximum face amount and that the employer will benefit; the consent should also say coverage may continue after employment ends.
• The insured must also fit an eligible category or exception; ask your CPA to confirm which one applies to each person.
• The employer reports on Form 8925 each year, and a material increase, replacement or new insured may call for fresh paperwork.
• If a step was skipped, only the premiums paid may come back tax-free, so fix the file with a professional before the application, not after the claim.