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Guidance on S Corporation Life Insurance Premiums Raises Questions

The IRS recently issued long-awaited guidance on the treatment of life insurance premiums paid and life insurance proceeds received by an
S corporation.

November 2008
by Kevin Walsh/The Tax Adviser

The IRS recently issued long-awaited guidance on the treatment of life insurance premiums paid and life insurance proceeds received by an S corporation. In Rev. Rul. 2008-42, issued July 1, 2008, the Service ruled that insurance premiums paid by an S corporation on an employer-owned life insurance contract on an employee of which the corporation is the beneficiary do not reduce the corporation’s accumulated adjustments account (AAA). The IRS further ruled that the receipt of tax-exempt life insurance proceeds by an S corporation does not increase AAA.

The fact pattern provided in the ruling was that of an S corporation with accumulated earnings and profits (AE&P) that purchased and paid premiums for a life insurance policy on the life of a key employee.

The rationale provided for the position taken in the ruling is that life insurance proceeds that are tax free under Sec. 101 constitute tax-exempt income as described in Regs. Sec. 1.1366-1(a)(2)(viii). This status as tax-exempt income removes the life insurance from AAA under the exclusion from AAA of tax-exempt income and related expenses (Sec. 1368(e)(1)(A)). Life insurance premiums paid on tax-exempt policies are considered to fall into the “related expenses” category and are thus excluded from AAA
as well.

This article has been excerpted from The Tax Adviser. View the full article here (PDF).

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