Naming a Business as Life Insurance Beneficiary: Rules and Tax Effects

Technical Summary: Business as Life Insurance Beneficiary

Yes. A corporation, partnership or other business can be named beneficiary of a life insurance policy. Treasury regulations state that the federal income-tax exclusion for death proceeds applies to any beneficiary, including a corporation or partnership. Two limits matter: a business that is a beneficiary cannot deduct its premiums, and an employer-owned contract may have the exclusion capped.

Owners, shareholders and finance leads usually ask this question when a business plan depends on cash arriving at a death. That plan might replace a key person, fund a buyout of an owner's interest or repay a business debt. Life insurance is the funding mechanism inside that plan, and the beneficiary designation decides where the money lands.

Business Life Insurance treats the beneficiary designation separately from policy ownership. Two federal tax questions arise when a business is named. The first is how the death benefit is taxed under 26 U.S.C. § 101(a)(1) and § 101(j). The second is whether premiums are deductible under 26 U.S.C. § 264(a)(1).

What "Business as Beneficiary" Means in Federal Tax Law

A beneficiary is the person or entity designated to receive the death benefit when the insured dies. Ownership is a different role. The owner controls the contract, and the owner often pays the premiums. The beneficiary only receives the proceeds. One business can hold both roles, or the roles can be split. Who should own the policy, and which tax regime ownership triggers, is a separate topic on this site. The roles are laid out in how business life insurance works.

The governing regulation addresses business recipients directly. Treasury Regulation § 1.101-1(a)(1) states that the exclusion "applies whether payment is made to the estate of the insured or to any beneficiary (individual, corporation, or partnership) and whether it is made directly or in trust."

Planning purposes that can involve naming a business as beneficiary include:

• key person insurance, which offsets the loss of a critical person
• entity-purchase buy-sell funding
• repayment of a business loan
• certain executive benefit arrangements

Applicable Federal Rules: The Statutes and Regulations That Govern

Seven provisions frame the question.

• 26 U.S.C. § 101(a)(1). This section provides that "gross income does not include amounts received (whether in a single sum or otherwise) under a life insurance contract, if such amounts are paid by reason of the death of the insured." The same paragraph names exceptions, including the transfer-for-value rule in paragraph (2) and subsection (j).
• 26 C.F.R. § 1.101-1(a)(1). This regulation extends the exclusion to "any beneficiary (individual, corporation, or partnership)."
• 26 U.S.C. § 264(a)(1). This section provides that no deduction is allowed for "Premiums on any life insurance policy, or endowment or annuity contract, if the taxpayer is directly or indirectly a beneficiary under the policy or contract."
• 26 C.F.R. § 1.264-1(a). This regulation applies the disallowance to a policy "covering the life of any officer or employee of the taxpayer, or any person (including the taxpayer) who is financially interested in any trade or business carried on by the taxpayer." It applies even where the premiums "would otherwise be deductible as trade or business expenses."
• 26 U.S.C. § 101(j). For an employer-owned life insurance contract, the exclusion "shall not exceed an amount equal to the sum of the premiums and other amounts paid by the policyholder for the contract." The cap does not apply when a § 101(j)(2) exception applies and the § 101(j)(4) notice and consent requirements are met.
• 26 C.F.R. § 1.61-2(d)(2)(ii)(A). Under this regulation, "Generally, life insurance premiums paid by an employer on the life of his employee where the proceeds of such insurance are payable to the beneficiary of such employee are part of the gross income of the employee."
• 26 U.S.C. § 101(a)(2). After a transfer for valuable consideration, the exclusion generally "shall not exceed" the consideration paid plus the premiums and other amounts the transferee pays afterward. Exceptions apply to carryover-basis transfers and to transfers "to the insured, to a partner of the insured, to a partnership in which the insured is a partner, or to a corporation in which the insured is a shareholder or officer."

Requirements: What Must Be in Place for the Rules to Apply as Intended

The § 101(j) notice and consent requirements are met only if, "before the issuance of the contract," three things happen. First, the employee is notified in writing that the policyholder intends to insure the employee's life, and of the maximum face amount. Second, the employee "provides written consent to being insured under the contract and that such coverage may continue after the insured terminates employment." Third, the employee is informed in writing that the policyholder will be a beneficiary.

Notice and consent do not lift the cap by themselves. A § 101(j)(2) exception must also apply, and an exception alone is equally insufficient. The exceptions are:

• Insured's status, § 101(j)(2)(A). The insured was an employee at any time during the 12-month period before death. Alternatively, at the time the contract was issued, the insured was a director, a highly compensated employee, or a highly compensated individual, as § 101(j)(2)(A) defines those terms by cross-reference.
• Amounts paid to heirs, § 101(j)(2)(B). This exception covers amounts paid to a member of the insured's family (within the meaning of section 267(c)(4)), a designated individual beneficiary other than the policyholder, a trust for their benefit, or the insured's estate. It also covers amounts used to buy an equity interest in the policyholder from one of those persons.

IRS Notice 2009-48 (A-7) states that a wholly owned corporation and its employee-owner are not excused from these requirements. It adds that actual knowledge alone cannot replace written notice and consent. Employer-owned contracts also carry an annual IRS reporting obligation.

The § 264(a)(1) disallowance applies whenever the taxpayer is directly or indirectly a beneficiary. Beneficiary designation forms and procedures for changing a beneficiary vary by insurer and by state.

How the Rules Work: Proceeds, Premiums, and the Business Beneficiary

Money moves in two directions, and each direction has its own rule.

Proceeds. When the insured dies, a business beneficiary generally excludes the death benefit from gross income under § 101(a)(1). For an employer-owned contract that does not meet both § 101(j) conditions, the excludable amount is limited to the premiums and other amounts paid. Any excess is gross income. For a policy taken out to get or protect a business loan, IRS Publication 334 states that "In the event of death, the proceeds of the policy are not taxed as income even if they are used to liquidate the debt." That general statement remains subject to the exceptions in section 101(a)(1), including section 101(j) and section 101(a)(2).

Premiums. A business that pays premiums and is a beneficiary cannot deduct them. Treasury Regulation § 1.264-1(b) adds that a taxpayer who takes out a policy "for the purpose of protecting himself from loss in the event of the death of the insured" is considered a beneficiary. The drivers of after-tax premium cost are covered in business life insurance cost.

Employee as beneficiary. In some arrangements the employer pays the premiums and the employee's chosen beneficiary receives the proceeds. In that case the premiums are generally the employee's income under § 1.61-2(d)(2)(ii)(A). The employer may deduct them as "a reasonable allowance for salaries or other compensation" under 26 U.S.C. § 162(a)(1), subject to reasonableness. This structure is often called an "executive bonus plan" or "section 162 plan." Both are industry terms, not qualified plans, and neither is defined in the Code or regulations.

Transfers. If the business acquires an existing policy for value, § 101(a)(2) may limit the exclusion unless an exception applies.

The § 101(j) requirements and the reporting obligation, transfer-for-value analysis, executive bonus deductibility and reasonableness of compensation, and § 264(a)(1) premium deductibility each depend on the contracts involved and need individual review with a qualified tax professional.

Who This Page Is For

The rules on this page reach several roles inside a business:

• owners and shareholders funding buy-sell agreements where the business or the co-owners are named beneficiaries
• employers carrying key person coverage payable to the business
• employers structuring executive benefits payable to an employee's family
• finance leads testing whether § 264(a)(1) disallows a premium deduction, or whether premiums qualify only as compensation under § 162(a)(1)
• owners of closely held corporations, partnerships and LLCs evaluating § 101(j)

Business partners have additional rules, covered in life insurance for business partners. The question of who owns the policy is a separate topic on this site.