Thursday, July 28, 2011

Big Corp Tax Loophole Closer #20: Janitor's Insurance

Many companies buy what is called “key-man” life insurance on particularly key employees, where the company is the beneficiary. This only makes sense because if a company loses a critical executive due to death, the company gets monetarily rewarded with the life insurance proceeds upon the death of the key employee.

The insurance premiums paid by the company each year are not tax deductible, for federal income tax purposes, and then the life insurance proceeds the company receives upon the employee’s death is tax exempt, for federal income tax purposes.

Each year, the company records on its books the increase in the cash surrender value of the life insurance policy as a long-term asset on its balance sheet, and with a like amount an increase in earnings on its income statement. This increase in cash surrender value each year is not taxable income.

Here’s the problem. Some smooth financial operators have seen the financial advantage of buying key-man life insurance on any employee of a company since just the tax benefits alone make the insurance policy quite advantageous to the company.

And to pile on, many of these life insurance policies are continued even after employees have left the company.

Clearly, buying life insurance policies for just regular employees of the company (thus the phrase Janitors’ Insurance or Peasants’ Insurance) is flat out abuse of the tax law.

Thus, my recommendation would be to just allow this favorable tax treatment to be on the life insurance policies on truly key employees…such as the Corporate Executive Management Team. Thus I recommend that there be no new Janitors’ Insurance policies allowed in the future.

The tricky part is what to do with all of the many present Janitors’ Insurance policies out there now?

I recommend that if the company decides to continue to keep this insurance coverage until the person dies, then fine, but the life insurance proceeds upon death gets reflected to the company as ordinary taxable income, for federal income tax purposes.

But then I would lessen the economic blow here by giving the company an incentive to cash in these life insurance policies now. I would let them cash them in during 2011 for their cash surrender value, and then the cash proceeds received by the company would be taxed as ordinary income at a favorable federal income tax rate of perhaps something like 15%.

The point here is that the country would be a lot better off if all of these Janitors’ Insurance policies are cashed in by companies for their cash surrender values as soon as possible.

And then to give even more of an incentive for companies to cash them in now, I would raise the federal income tax rate on the cash surrender value by say 2% per year for each additional year the insurance policy is retained by the company.

The tax proceeds received by the US government from this recommendation should be used to reduce the US Deficit.