Clients needs a keyman insurance policy

Apr 2, 2019

  1. Allen Trent

    Allen Trent Guru

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    I believe this is incorrect. I believe you are thinking of the Transfer for valuable consideration IRS regulations, but that section of the code has several exemptions including when the receiver of the policy is the insured on the policy. I believe the example in this post as a term policy would meet that standard. Also, because Key Man policies cannot be deducted by the employer when the business is the owner & insured, it is also possible even a permanent policy used for Key Man would meet the IRS transfer for valuable consideration exemptions.

    I may be reading this post wrong, but I believe IRC 101(a) is what comes into play
  2. Robert Barney

    Robert Barney Guru

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    If I understand you correctly, the key man policy (term) could be transferred to the employee without a tax liability to the employee. That was the way it worked in Canada. The only issue was when there was a CSV in a policy, and then the value of that CSV became a taxable benefit to the employee.

    Many smaller companies are owned by their key man. It makes sense to overbuy a key man policy (say a 30 year term on a 55 year old owner) who when they turn 65 and retire, or when they sell the business, personally take over the policy. It moves from being a key man policy to an estate planning product with the company having paid the toughest years of premiums.

    If I am correct, and the only taxable benefit of a no lapse UL product would the products's account value, then that same strategy could be used to have a company own the permanent policy as key man insurance, and then the employee (owner) take over the policy on retirement or sale of the company. Permanent insurance makes a much better estate planning tool and once again the company picks up the most expensive costs of the policy in the early years.

    Either way, if you do the math, the company pays some of the hardest costs for the product, and the employee takes it over at a favorable time in the future. In the meantime, if the employee dies, the company gets a tax free death benefit (which is why the premiums are not tax deductible) and the company has a legitimate argument that they no longer need the product when the employee leaves.

    Happy to be corrected, but this is a strategy we often used to get small business owners to buy key man policies.
  3. scagnt83

    scagnt83 Worldwide Expert of Everything

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    South Carolina
    If I remember correctly, that exemption only exists if the Key Employee is a 2% or more Shareholder. Then it is considered a "Return of Capital or Investment".

    There is also a heck of a lot of grey area in 101(a) that is yet to be decided by case law.

    But if it's an employee who is not a shareholder, its a Transfer of Value and considered Taxable Compensation. They are assessed FMV (fair market value).

    To determine Fair Market Value, the IRS uses either the Modified ITR (interpolated terminal reserve) of the policy, or PERC (premiums, plus earnings, minus reasonable charges).

    And for Term, that would be the Premiums paid up to that point.