Long Awaited BOLI Clarification
Some banks may not even realize it, but maintaining a Bank Owned Life Insurance (BOLI) policy may have just gotten easier as of late March, courtesy of the Internal Revenue Service (IRS) and the Treasury Department.
Specifically, on March 22nd the IRS and Treasury issued proposed regulations related to new reporting rules for certain transfers of life insurance policies, including BOLI. If adopted, those new regulations will clarify the tax reporting requirements for BOLI policies that are transferred as part of a bank merger or acquisition.
BOLI policies generally insure the lives of bank executives or other highly compensated bank employees. The bank pays a single premium, owns the policies and is the beneficiary of death benefit proceeds and, in most cases, shares the death benefit with the insured’s beneficiary. The bank generates tax-free non-interest income from the underlying investments of an insurance company’s general or hybrid account portfolio. BOLI tax-free earnings are used to indirectly offset the cost of employee benefit programs.
The need for the this new clarification arose out of the Tax Cuts and Jobs Act of 2017 (TCJA) and the Transfer-for-Value Rule, which inadvertently said that death benefits for employer-owned life insurance, like BOLI, could under certain circumstances be included in gross income for the purposes of taxation – something that had never been the case before.
As an example, let’s say that Bank A acquired Bank B, and Bank B Employee X – covered by a BOLI policy—is terminated as part of the transaction. Under the TCJA, when Employee X died, some of the BOLI proceeds for Bank A would now be taxable. Keep in mind that, in this scenario, Bank A had no substantial family, business, or financial relationship with Employee X other than the life insurance policy in question.
So what would Bank A need to consider when it came to taking over Bank B’s BOLI policies? First, it would have to decide whether to surrender the policies and no longer offer them, or keep them on the books. The latter option comes into play particularly when it comes to paying death benefits; oftentimes an employee-owned life insurance policy provides at least some of those benefits to the decedent’s family, so those obligations still need to be met – an obligation that Bank A arguably took on when it took ownership of Bank B’s BOLI policies.
While the transfer-for-value rule had historically not applied to policies acquired in a Bank A/Bank B style merger scenario, that changed with the TCJA. Thus, to repeat: if a bank acquired a BOLI policy in a merger or acquisition, the death benefits received from the policy could be taxable.
In addition, Bank A may have needed to include a Deferred Tax Liability (DTL) on its books. The DTL could be used in two ways; in the first, the initial DTL would be based on the total policy cash value minus the initial cost basis as of the date of the transaction/acquisition. The DTL could then be periodically updated based on the current cash value minus the current cost basis, where the current cost basis equals the initial cost basis plus any additional premiums paid.
The other strategy involves establishing a DTL based on the policy death benefit minus the initial cost basis as of the date of the transaction/acquisition. That amount could also be adjusted periodically if additional premiums were paid – thereby decreasing the DTL — or if the policy death benefit changed due to policy design or market conditions.
If you feel a headache coming on, so too did BOLI providers, policy owners, and government officials. The recent clarification proposed by the IRS and the Treasury Department would provide that tax-free transfers of BOLI policies between banking organizations organized as C-corporations – ones in which the owners or shareholders are taxed separately from the entity — that do not have more than 50 percent of their assets in BOLI policies would NOT be subject to new reporting requirements applicable to certain transactions involving life insurance contracts. The proposed amendments would also clarify that tax benefits associated with the receipt of proceeds from transferred BOLI would be eligible for exclusion from income.
Comments on the proposed amendments are forthcoming, but the belief here is that the changes will take effect.
Meanwhile, we are still awaiting clarification on how the new proposal will be applied to S-corporations, which, in general, do not pay any income taxes. Instead, the corporation’s income or losses are divided among and passed through to its shareholders, who then must report the income or loss on their own individual income tax returns.
The federal government can, as we all know, move in mysterious ways. But in this BOLI-related case, it looks like it might actually take some of the mystery away.
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