EOLI Notice and Consent: What Must Happen Before the Policy Is Issued

Technical Summary: Section 101(j) Notice and Consent at a Glance

Before an employer-owned life insurance contract is issued, the insured employee must receive written notice that the employer intends to insure his or her life and of the maximum face amount, must give written consent that also covers coverage continuing after employment ends, and must be told in writing that the employer will be a beneficiary. Section 101(j)(4) of the Internal Revenue Code sets these conditions, which must be met before the section 101(j)(2) exceptions can apply.

The question usually comes from a business owner, officer or finance lead whose company is about to buy coverage on an employee's life to fund key-person risk, a buyout or another business obligation. The insurance is the funding mechanism. The notice and consent determine how much of its death benefit the Code may exclude from the business's income.

Section 101(a)(1) generally excludes death benefits from gross income, subject to limits that include the transfer-for-value rule in section 101(a)(2) and the employer-owned rule in section 101(j). Section 101(j)(1) caps the exclusion at "the sum of the premiums and other amounts paid by the policyholder for the contract." The cap is lifted only when a section 101(j)(2) exception applies and the notice and consent requirements were met. Either condition alone leaves the cap in place. Annual reporting runs through Form 8925 under section 6039I, and Notice 2009-48 is the IRS guidance that interprets both sections.

Definition: What Is an Employer-Owned Life Insurance Contract?

Section 101(j)(3)(A) defines an employer-owned life insurance contract as one that "(i) is owned by a person engaged in a trade or business and under which such person (or a related person described in subparagraph (B)(ii)) is directly or indirectly a beneficiary under the contract, and (ii) covers the life of an insured who is an employee with respect to the trade or business of the applicable policyholder on the date the contract is issued."

The "applicable policyholder" is the business that owns the contract. Under section 101(j)(3)(B), the term also includes certain related persons specified in the Code and businesses under common control.

Section 101(j)(5)(A) provides that "employee" includes "an officer, director, and highly compensated employee." Notice 2009-48 Q&A-5 adds that a director is an independent contractor in that capacity but still counts for this rule.

Ownership decides the result. Notice 2009-48 Q&A-1 states that a contract owned by an owner of the entity, for example to finance buying another owner's interest, is not employer-owned. Q&A-3 states that ownership by a partnership or sole proprietorship does not prevent a contract from being employer-owned. The same answer states that a sole proprietor's policy on his or her own life is not employer-owned. The site's employer-owned life insurance and corporate-owned life insurance pages cover the broader definitions.

Applicable Rules: The Statutory and Guidance Framework

These federal provisions and guidance govern this topic.

• 26 U.S.C. § 101(a)(1) generally excludes amounts "paid by reason of the death of the insured" from gross income.
• 26 U.S.C. § 101(j)(1) caps that exclusion for an employer-owned contract at premiums and other amounts paid.
• 26 U.S.C. § 101(j)(2) lists the exceptions. Subparagraph (A) is based on the insured's status: an employee at any time during the 12-month period before death, or, when the contract is issued, a director, a highly compensated employee or a highly compensated individual. Subparagraph (B) covers amounts paid to the insured's family, designated beneficiary, a trust for them, or the estate, and amounts used to buy an equity interest in the policyholder from those persons.
• 26 U.S.C. § 101(j)(4) sets the three notice and consent elements.
• 26 U.S.C. § 6039I requires annual returns and records.
• Notice 2009-48 answers interpretive questions on both sections.
• Form 8925 is the IRS return used for the annual report.

Requirements: The Three Elements of Valid Notice and Consent

Section 101(j)(4) provides that the requirements "are met if, before the issuance of the contract, the employee":

"(A) is notified in writing that the applicable policyholder intends to insure the employee's life and the maximum face amount for which the employee could be insured at the time the contract was issued, (B) provides written consent to being insured under the contract and that such coverage may continue after the insured terminates employment, and (C) is informed in writing that an applicable policyholder will be a beneficiary of any proceeds payable upon the death of the employee."

The statute joins the three elements with "and," so a document that leaves one out does not meet the test. An enrollment or beneficiary form that never mentions coverage after termination, or the employer's beneficiary status, falls short.

On face amount, Form 8925 describes Q&A-12 this way: the notice must disclose the face amount "either in dollars or as a multiple of salary, that the policyholder reasonably expects to purchase with regard to the employee during the course of the employee's tenure." Additional notice and consent are required if aggregate coverage exceeds the amount the employee was told about and consented to.

On delivery, Form 8925 states that the requirement "can be met electronically only if the system for electronic notification and consent meets requirements 1 through 3," citing Q&A-11. Notice 2009-48 Q&A-11 adds that the system must also (1) ensure that the information the employee receives is the same as the information the employer sent, (2) make it reasonably certain that the person accessing the system is the employee, (3) include a process for electronic signature or other means of formally recording the employee's consent to being insured, and (4) permit the production of a hardcopy of the electronic notice and consent, with a statement, on the IRS's request.

How the Rules Work: Timing, Issuance, and the Two-Condition Structure

Timing is the hinge. Form 8925, citing Notice 2009-48 Q&A-4, states that for notice and consent purposes the issue date is "the later of (1) the date of application of coverage, (2) the effective date of coverage, or (3) the formal issuance of the contract." Consent obtained after that date does not meet the statute's "before the issuance" test.

Consent also expires. Form 8925, citing Q&A-9, states that a written consent is not valid unless the contract is issued "within a year after the consent was executed, or before the employee terminates employment with the trade or business of the applicable policyholder, whichever is earlier."

The exceptions do not replace consent. Notice 2009-48 states that even when a section 101(j)(2)(A) or (B) exception "is otherwise satisfied," the notice and consent requirements must be met for the cap not to apply. That applies equally to the 12-month employment exception, the family-proceeds exception and the equity-purchase exception.

The analysis follows three questions:

1. Is the contract employer-owned under section 101(j)(3)?
2. Were valid notice and consent completed before issuance?
3. Does a section 101(j)(2) exception apply?

If the answer to the first question is yes and either the second or third answer is no, section 101(j)(1) caps the exclusion.

Who This Is For: Employers Subject to Section 101(j)

The rule reaches any business that owns life insurance on someone who counts as its employee and that is directly or indirectly a beneficiary. Notice 2009-48 Q&A-3 confirms that partnerships and sole proprietorships are included, along with corporations. Covered insureds include rank-and-file employees, officers, directors and highly compensated employees on the issue date.

Notice 2009-48 Q&A-7 states that notice and consent are required of an owner-employee of a wholly-owned corporation, and that "actual knowledge alone" cannot substitute for the written requirement.

Readers include:

• owners and partners funding continuity or buyouts through entity-owned policies;
• finance and HR leads running existing programs that have not confirmed consent for each insured; and
• advisers evaluating how coverage between business partners is structured.

Employer-owned life insurance notice and consent under section 101(j), and Form 8925 reporting, need individual review of the contracts involved by a qualified tax professional. The checklist specific to key-person coverage belongs to the site's key-person insurance requirements page.