Generally speaking, life insurance policy proceeds are not included in taxable income. However, a little-noticed provision of the Pension Protection Act of 2006 was recently highlighted in a new Internal Revenue Service Notice (Notice 2009-48). IRS Code Section 101(j) provides that for employer-owned life insurance policies on employees, officers, and directors and others, the difference between the premiums paid and the death benefits is taxable as ordinary income if the policy was issued after August 17, 2006.
Fortunately, there are a limited number of exceptions available (including those for key-man policies) but these exceptions are available only if the insured, whether an employee, officer or director, signs a "notice and consent" containing certain required disclosures about the life insurance purchased by the employer.
Surprisingly, many life insurance carriers, brokers, agents, and employers are placing life insurance without first obtaining the notice and consent required under 101(j), thereby causing a good portion of the life insurance proceeds to be income taxable to the employer on the insured's death. In many cases, this entire tax could be avoided.
There are also some new IRS reporting requirements (on a Form 8925) for these employer-owned policies.