Proposed COLI Deduction Limit could Impact NQDC Programs

May 15, 2009 ( - Employers who have relied on corporate owned life insurance (COLI) to fund either non-qualified deferred compensation benefits or other post retirement benefits not funded in a tax-deferred manner may find that option at least partially closed off in coming months.

A client advisory prepared by The Groom Law Group said the restriction could come from an Obama administration proposal to deny a pro-rata portion of the interest deduction based on insurance held on any individual other than a 20% owner of the business. That “greatly expands” the current situation which, according to the Groom memo, involves pro-rata denial of the interest expense deduction that currently applies to COLI on individuals who are not employees.

The Administration’s proposal for COLI would raise approximately $8.5 billion in tax revenues over a ten year period and is part of a package of proposed tax changes which the administration hopes will generate enough revenue to fund its health care delivery system changes.

“By reducing the tax deduction for other interest paid by the business, the tax and economic benefits of purchasing life insurance on employees is severely diminished,” the Groom memo asserted. “Consequently, if this provision is enacted, companies probably will be less likely to use COLI to fund non-qualified deferred compensation or other retiree benefits.”

Groom indicated the proposal is intended to apply prospectively, so no current COLI policies would be affected.

The memo pointed out that a similar measure died in Congress during the Clinton administration but might have a better chance in the current political environment.