While taxpayers continue to evaluate the impact of the new Tax Act on their pocketbook, one thing has become clear; the tax bill supports the life insurance industry. Cash value accumulation remained a tax-deferred growth vehicle, loans against cash value continue tax-free within policy limits, and income tax free death benefits reserved for the individual market now has similar advantages in the corporate market.
Here are 3 tax law changes impacting the corporate owned life insurance market which every business should know:
- Reduction in the Corporate Tax Rate: The reduction of the corporate tax rate to 21% for C-Corporations fundamentally changes the approach to purchasing life insurance for owners and for businesses looking to reward key employees. With the potentially higher personal tax brackets, there is a distinct advantage to having life insurance policies owned by the corporation. One advantage is using the lower tax bracket to purchase the policy; the second advantage is realized when the employer pays out a retirement income to the key employee. As example, if the agreement is to pay the key employee $50,000/year for 10 years at retirement age, the after tax to the employee at the 37% rate would be $31,500 and it would take $39,873 of cash value from a corporate owned life insurance policy to generate that amount at the 21% tax rate.
- Elimination of Corporate Alternative Minimum Tax: A permanent change in the tax code, this eliminates the additional tax levied to corporations owning life insurance on key employees and owners/shareholders. Previously, any death benefit proceeds above cost basis would have been included in the corporate AMT which could lower the net proceeds from life insurance to the company of up to 20%. This allows the employer to fulfill their retirement income obligations to the key employee, and retain the policy as an asset on the balance sheet with no corresponding liability. Corporate owned life insurance can also be of value to a business as collateral when seeking additional financing.
- Tax Savings for 2018: Life insurance is an attractive vehicle for cash accumulation within a corporation as the cash values remain accessible for liquidity to the business and the funds can avoid the additional tax associated with retained earnings when structured properly to meet normal business needs (like key person coverage). Using the 2018 tax savings to purchase corporate owned life insurance allows the business to build cash reserves as working capital, a rainy day fund, or for succession planning to assist with ownership transfer. Companies which spend time preparing for ownership transition are typically the most successful at making the change, and having assets available to assist with the buy-out makes the company attractive to the next generation of ownership.
Life Insurance can be an effective tool for cash accumulation and wealth transfer, and the new tax law changes make corporate owned life insurance even more attractive. Corporate owned life insurance requires notice and consent from the insured and annual tax reporting; make sure to work with an experienced insurance professional who can design a plan that’s right for your organization.
David Hillelsohn founded DHill Financial, LLC with the mission of enhancing the cohesion among families and businesses by prioritizing meeting obligations and taking steps to ensure people know you care. His vision is for people to want to do for others thereby doing for themselves. David is an independent agent licensed in the majority states around the country, and he can be reached at 703.435.6028 or by email at email@example.com. This article is not meant to be tax advice, please consult a tax professional for details.