Life Insurance Dilemma

[samingeorgia]

Here is a situation I have not faced before.

XYZ Corporation owned a "key man" policy on the son of the founder. The policy was paid up and no additional premiums were due. About 15 years ago, XYZ closed and liquidated its assets. Except, of course, for the insurance policy.

Now, the son is going over old paperwork and has found the policy. He talked to the insurance agent, who pointed out that the policy is still owned by XYZ. My opinion is that XYZ should have distributed the policy to the son (who was a shareholder) as a dividend or additional compensation or something. But that wasn't done. The son wants to change the beneficiary from XYZ to his spouse.

What, if anything, should the son declare on his tax return? It's obviously way too late to amend a 1997 tax return. My gut tells me that he should pick up the cash surrender value as other income. I guess it should be stated as "Misc. Income" on the 1040, I don't think it would be too good to show a dividend from a company that no longer exists.

For discussion purposes, the death benefit on the policy is +/- $ 200K. I don't know the cash surrender value (now or in 1997) but the son can get it for me.

[kcjenkins]

I'd base the FMV on the cash surrender value now, since it is only now that he has actually 'gotten' the policy. Misc Income Line 21 seems the most logical place to report it. I've never had that sort of situation, hopefully someone who has will speak up and share the outcome.

[Guest Taxed]

Also key man policies may have a cost basis because each year the insured is suppose to pay tax on something called PS 58 cost.

This is an actuarial table that is based on age and attributes a "cost of insurance" factor to the insured. The insured is suppose to put that down on line 21 as misc income each year.

I have one client who gets a letter (NOT a 1099 or other tax document) from Northwestern Insurance company each year regarding this matter.

I would think the cumulative cost or taxes paid has to be factored in somewhere to arrive at the taxable amount.

[jklcpa]

The PS 58 cost is only for split dollar life insurance and doesn't seem to apply here. Because George said this policy has CSV, it is probably a whole life, or it could be universal life too. Many of those universal life policies ended up with no CSV because the earnings estimates that were used in the beginning were too high and they never met the earnings that were projected when the policies were purchased.

George is correct that it should have been distributed out. I'm not sure where to report it either.

That corporation is lucky that the insured didn't die while the corporation was listed as the beneficiary. While life insurance proceeds aren't usually taxable to a corporation for regular income tax, they have to potential to be taxable as part of the ACE adjustments for the corporate AMT. I have a corporate client that had substantial amounts of whole life coverage on the 3 owners that was to be used in the event of a shareholder's death as part of the buy-sell agreement of the corporation. That corporation would have paid a lot of tax on those proceeds. Those policies were transferred out of the corporation and into a partnership owned by the same individuals and in the same percentages as in the corporation, and that partnership's interaction was incorporated into the buy-sell agreement.

[jklcpa]

If it had been accounted for properly in the corporation with the increase in CSV in excess of the premiums paid each year, at least there shouldn't have been a gain in the corporation from the distribution of the policy out of the corporation. That is, *if* it had ever been distributed in the first place!

[Max W]

There may be no tax issue here at all, because there may not be any money coming from the insurance. Since the policy was paid in full at the time it was created, it is probably a term policy, so there is no cash value. The corp is/was the beneficiary only in the event that the key person, the son, died. This did not happen.

Then, even if there is a possibility of collecting something, how does the son go about changing the beneficiary?

The first step is for the son to find out if there is any possibility of collecting anything.

[Guest Taxed]

Because the owner of the policy (the XYC corp.) no longer exists, can the insured even change the beneficiary from the now defunct XYZ to someone he chooses?

I know the rules on compny owned life insurance (COLI) has changed a lot since 2006 but this issue predates that.

What would happen if the insured died right now? Because the beneficiary on the policy (XYZ) no longer exists would the death benefit be escheated? Is there a successor to the XYZ corporation?

If this was my client I would advise him to seek legal advice and have the attorney give an opinion before i signed my name on the 1040.