Does Your Company Need Employee Consent for Key Person Insurance?

Under IRC § 101(j), an employer-owned life insurance contract can qualify for certain exceptions to the cap on the tax exclusion only if the employee receives written notice and gives written consent before the contract is issued. Without them, the death benefit may not get the full income tax exclusion. This page explains the rule in plain words for business owners and for employees who were handed a form.

Short answer: when is written employee consent required?

Written consent is required when a business owns a life insurance policy on an employee and wants the death benefit excluded from income under the employer-owned rule. The rule is a tax rule. Whether a company may buy a policy on a key person’s life depends on the facts of the case and the rules that apply to it.

Nischay Rawal, a licensed insurance agent, handles the policy side. Tax questions sit with the firm’s accounting practice. Insurance is offered by the licensed agent, separately from the accounting practice.

The consent question matters because it decides how the death benefit is treated for tax purposes.

The federal notice-and-consent rule for employer-owned life insurance

The rule says the death benefit stays fully excluded from income only when notice and consent requirements are met. Congress added the related reporting rule in 2006 (IRC § 6039I).

Under IRC § 101(j), the amount excluded from income cannot exceed the premiums and other amounts the policyholder paid. For an employer-owned life insurance contract where the notice and consent requirements of IRC § 101(j)(4) are met, the cap in § 101(j)(1) does not apply to certain listed amounts, such as amounts received by reason of the death of an insured who, with respect to an applicable policyholder, meets the status tests in § 101(j)(2)(A).

Two plain-word terms help. An employer-owned policy is one the business owns and pays for. A key employee is someone whose loss would cause the business financial harm. The Insurance Information Institute explains that key person coverage compensates a business for financial losses caused by a key employee’s death or disability.

The rule also has exceptions. Which ones apply depends on the facts.

What the employee notice and consent should cover

The notice and consent should be in writing and dated before the policy is issued.

• Notice of intent. The employee is told in writing that the business intends to insure the employee’s life. The employee also learns the maximum face amount, which is the coverage amount, he or she could be insured for.
• Written consent. The employee gives written consent to being insured under the contract.
• Continuing coverage. The consent states that coverage may continue after the employee leaves the job.
• Beneficiary disclosure. The employee is told in writing that the business will be a beneficiary of any death benefit.

These points come from the notice and consent language in IRC § 101(j).

Recordkeeping follows the policy. Each year, an applicable policyholder owning 1 or more employer-owned life insurance contracts files a return. It reports whether valid consent was obtained for each insured employee, or how many insured employees did not give consent. The owner must also keep records. See IRC § 6039I.

Can a company insure an employee without the employee knowing?

Under IRC § 101(j), the income-tax exclusion for the death benefit of an employer-owned policy is generally capped at the premiums and other amounts the employer paid, unless the employee receives written notice and gives written consent before the policy is issued and one of the exceptions listed in § 101(j)(2) applies.

A policy taken out without that notice does not meet the notice and consent requirements. The death benefit exclusion is then capped at the premiums and other amounts paid. IRC § 101 reads: “(1) General rule In the case of an employer-owned life insurance contract, the amount excluded from gross income of an applicable policyholder by reason of paragraph (1) of subsection (a) shall not exceed an amount equal to the sum of the premiums and other amounts paid by the policyholder for the contract.”

A common mistake is signing the employee form after the policy is already issued. The rule looks at timing.

The tax result depends on how the policy and notices are documented. The firm’s accounting practice can review the tax side, and the licensed agent can review the policy side.

Who is the beneficiary, and what is key person insurance for?

The business is typically the beneficiary of a key person policy. Its purpose is to help the company manage financial loss tied to a key employee’s death or disability.

The business receives the death benefit and decides how to use it. The employee must be told in writing that the business will be the beneficiary.

The employee’s signed consent should also address coverage after employment ends. A policy can continue past an employee’s time with the company only if the consent and the policy terms allow it. Our page on key person insurance when an employee leaves covers that question in more detail.

If you were asked to sign a consent form: next steps

If you were handed a consent form, read it before you sign. You may be the employee who received the form, or the owner who wants the paperwork right. Either way, slow down and ask clear questions.

Check four things before signing:

1. Who owns the policy?
2. Who is the beneficiary?
3. What is the face amount?
4. Does the consent say coverage can continue after employment ends?

If any answer is unclear, bring the form to a coverage review. Nischay Rawal, a licensed insurance agent, can review the policy side with you. The firm’s team can discuss the tax side through the separate accounting practice. To request a coverage review, visit our contact page.

When does notice matter for employer-owned life insurance?