At American Business, a key element of our mission is to educate trusted partners and their clients on life insurance matters that can better inform their decision-making when it comes to life, long-term care and disability insurance protection.
Through 50-plus years in business, our firm’s professionals have offered array of independent and sophisticated solutions to our clients. Through our experiences, insights and broad industry network, we’ve also identified a multitude of common insurance-related tax traps that can put clients in very difficult positions without any knowledge or intent on their part.
Below are some significant examples of these traps.
(1) Lack of “acknowledgment and consent” documentation on any employee for which a company is buying insurance. As an example, consider a hypothetical key person insurance policy (i.e., life insurance on the key person in a business) that was purchased on the corporate level. If that procedure wasn’t filed, the proceeds from the policy would be subject to taxation. Note that this falls under IRS Notice 2009-48, which addressed outstanding questions regarding treatment of employer-owned life insurance contracts under IRC §§101(j) and 60391 (requiring annual reporting on Form 8925).
(2) The Goodman Triangle. This “triangle” consists of three parties: Insured A, Owner B and Beneficiary C. As an example, assume Insured A is a husband, Owner B is the wife and Beneficiary C is a daughter. Just by virtue of its structure, a taxable event is created. There is no sound reason to formulate such a structure in a policy arrangement; you can steer clear of the Goodman Triangle tax trap simply by utilizing a different owner or trust.
(3) Inadvertent lumping of life insurance premiums with property and casualty (P&C) and medical insurance premiums in an attempt to make those life insurance premiums tax-deductible. Oftentimes, this occurs through simple passive ignorance. Still, life insurance premiums are not tax-deductible, except in a pension plan, so this should not be done.
(4) Losing step-up in basis because a buy/sell agreement was written in a stock redemption format instead of a cross-purchase format. When this occurs, the stock could be redeemed upon the death of “A” but that share of the stock does not get a step-up in basis when “B” sells the company.
(5) Gifting an insurance policy into a trust instead of selling it to that trust, which is done in order to avoid a three-year “contemplation of gifting.” When someone gifts a policy to a trust, they must survive for three years; otherwise, the face value of that policy is brought back into the estate, and nothing positive is achieved as a result. To avoid this, it’s advised that the trust purchases such a policy for its value with no associated three-year contemplation.
(6) Avoiding income tax on surrendered or lapsed policies that are heavily loaned (i.e., policies that have large loans against the cash value, which, in turn, could cause the policy to either lapse or be surrendered). The strategy to avoid this is called loan rescue, where selected companies will take over those policies that are heavily loaned, preventing the lapse from occurring and therefore preventing the taxable event.
Trusted Insurance Partners Can Help Clients Avoid Insurance Tax Traps
The takeaway here is simple: There are significant taxable implications of life, long-term care and disability insurance policies. Without even knowing it, insureds can fall prey to the tax traps we described above, as well as many others. Insurance pathways are always best traveled with an experienced, independent and trusted partner. At American Business, we appreciate the opportunity to bring these important issues to light, and help you and those close to you navigate the complex and evolving life, long-term care and disability insurance landscape.