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How a Tax Free Asset Becomes Taxable

1. August 2018 09:41

(Part 5 of 6)
 
Life Insurance Payouts are always Tax Free – Think Again 
 
A misconception of many successful business owners is that life insurance payouts are always tax free. They should be, but many times the death benefit can become taxable both on an income and estate tax level. Are you absolutely positive your life insurance benefits will be tax free? How do you know and what are you basing it on?

There are various reasons that cause life insurance benefits to be taxed substantially. Because of space restraints I will only mention one. It is directly tied into the Pension Protection Act of 2006. Specifically, if an entity (corporation, LLC, partnership, etc.)  owns life insurance on an employee (even the business owner) and an acknowledgement and consent was not signed prior to issue of the policy, the entire death benefit will become income taxable. A recent example is a new client of mine. While reviewing various legal documents and insurance contracts I came across corporate owned insurance policies that were acquired for business buyout purposes. The total insurance amount was $125 million. An acknowledgement and consent form wasn’t signed by any of the insureds – that means every dollar of the $125 million will ultimately be taxed. The only options to avoid unnecessarily paying legally avoidable taxes in the tens of millions of dollars is for the clients to scrap the insurance and start new. This problem cannot be corrected any other way.

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