The general section of the life exam always includes a few tax and business-insurance questions. These are the rules behind them.
Personal taxation
- Death proceeds are generally income-tax-free to the beneficiary, unless the policy was transferred for value.
- Section 1035 exchanges: no gain or loss is recognized when a life policy is exchanged for another life policy, an endowment, an annuity or a qualified long-term care contract.
- Modified endowment contracts: a policy that fails the federal 7-pay test is a MEC. Taxable amounts taken out of a MEC face an extra 10% tax, except after age 59½, on disability, or as part of substantially equal periodic payments.
Key person insurance
A business buys key person insurance to offset the loss of a key employee. The business owns the policy and is its beneficiary, which is why the premiums are not deductible.
Buy-sell agreements
Business owners agree to buy the share of an owner who dies or becomes disabled, with the value and terms set in advance. Life insurance funds the purchase at death; disability buy-out insurance funds it at disability.
Executive bonus and split-dollar
- In an executive bonus plan, the employer pays premiums on a policy whose proceeds go to the employee's chosen beneficiary.
- A split-dollar arrangement is, in most cases, between an owner and a non-owner of a policy, sharing premiums and benefits. The IRS taxes it under one of two mutually exclusive rules: the economic benefit rule or the loan rule.
Anti-money laundering
Federal anti-money-laundering rules cover permanent life insurance (other than group), annuities other than group annuities, and other products with cash value or investment features. The insurer, not the agent, files suspicious activity reports, and no one may tell the customer.