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Saturday, May 15, 2010

Corporate-Owned Life Insurance (COLI):Insurance and Tax Issues

Baird Webel
Specialist in Financial Economics

Donald J. Marples
Specialist in Public Finance

Life insurance policies taken out by and payable to companies on their employees, directors, officers, owners, and debtors are commonly known as corporate-owned life insurance (COLI) policies. (COLI is also known as company-owned life insurance.) Such policies are separate and distinct from typical group life insurance policies offered to many employees as an employment benefit. In general, only the company, not the employee's family or other beneficiary, receives any benefit from a COLI policy. In some cases, employees or their families have no knowledge of any policy being taken out. Concerns about people "gambling" on the deaths of strangers has led to "insurable interest" laws in most states that require some possibility of financial loss as the result of an insured's death as a prerequisite for the purchase of life insurance. Although employment has generally been accepted to fulfill the need for an insurable interest, many have expressed concern about employers holding policies on lower-paid employees and continuing to hold policies after a worker has left employment. 

Although the chief historical justification for the favorable tax treatment of life insurance focuses on individuals, not companies, COLI policies enjoy the same basic preferences as other life insurance. As a result, a corporation enjoys either tax-deferred or tax-free growth of funds invested in COLI plans. These tax preferences are a large reason for companies to choose COLI policies rather than simply investing the money in a more straightforward way. Moreover, under certain circumstances, companies have taken loans using the cash value of the life insurance policy as collateral, used the loan proceeds to pay for the premiums of the life insurance policies, and then deducted the interest expense from their taxable income, further enhancing the advantages of COLI-related transactions. In the past, Congress has restricted the tax advantages of COLI, including limiting instances in which loan interest is allowed to be tax deductible. The 108th and 109th Congresses saw several bills introduced as well as floor and committee amendments on COLI. Language limiting COLI's tax advantages to policies taken out on the highest-paid 35% of employees and linking tax advantages to employee notice and consent was agreed to in the Senate Finance Committee in 2004 and ultimately incorporated into P.L. 109-280, which was passed by the 109th Congress in 2006. 

In the 111th Congress, the Life Insurance Employee Notification Act (H.R. 251), introduced by Representative Gene Green, would require employee notice of COLI, similar to those enacted in 2006, but would enforce these requirements through the Federal Trade Commission Act, rather than the Internal Revenue Code. Representative Luis Gutierrez's Employer-Owned Life Insurance Limitation Act (H.R. 3669) would require disclosure of COLI policies to employers and limit COLI policies to employees with a salary of more than $1 million per year. H.R. 3669 includes a civil private right of action and criminal penalties. 

This report begins with a general background on COLI, followed by current proposals on COLI. It then addresses federal limitations on COLI from previous years, discusses state approaches to the issue, and concludes with an analysis of the issue from a public-finance perspective. An appendix provides a detailed discussion of legislation addressing COLI from the 108th through 110th Congresses. 

Date of Report: May 4, 2010
Number of Pages:15
Order Number: RL33414
Price: $29.95

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