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How IRS Tax Exempt Rules Affect Key Man Life Insurance

By Byron Udell | July 25, 2008

How does the 2008 IRS tax exempt rules Key Man Life Insurance for S-Corporations? To find out, read on.

A 2008 Internal Revenue Service addressed the tax exempt treatment of life insurance policy proceeds on Key Man life insurance policies of Sub-chapter S-Corporations; medical and/or otherwise.

The 2008-42 Revenue Ruling addresses the issue of whether an AAA financial credit rating will be affected by the following two factors:

  1. The premiums paid by an S-corporation on a life insurance policy owned by the employer
  2. The benefits assured to the concerned S-corporation due to the death of the insured

In 2008, the Internal Revenue Service ruled in this area while addressing the tax-exempt treatment of the life insurance policy. The ruling concluded that the two factors mentioned above; mainly the premiums paid by the beneficiary and the benefits accorded to the corporation after death of an insured employer, do not reduce the S-Corporation’s AAA. Further, the benefits received because of the death of the insured from an employer-owned life insurance contract that meets an exception under Code Sec. 101(j)(2) do not increase its AAA.

What does this mean?

Basically, life insurance proceeds on “key-man” life insurance policies in an S-Corporation are essentially trapped in the corporation.  Any distribution of that cash to surviving S-Corporation shareholders – or to the estate of the deceased shareholder – triggers a taxable event.  It is therefore vital for any business with a life policy paid by the business, or other S-corporation, to discuss the tax policy and estate planning particulars with your accountant.

More About Key-Man Insurance Policies and Small Business Life Insurance

Check out this quick video for additional information about key-man and other business-related life insurance.


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