PS 58 costs never reported

[ombskid]

An accountant asked me this question:

Small business owner has had life insurance in a profit sharing plan for 15 or so years. No one ever reported PS-58 costs to the accountant and they were never picked up as income. What are the tax ramifications if the plan is terminated? They probably want to cash in the policy (they don't need the insurance) and roll over the account balance.

[Jim Chad]

I can see why no one wanted to answer this. Here are my thoughts. FWIW

The right thing to do is get the PS 58 amounts, issue 1099's and amend tax returns. Yes, I know what you are thinking. Amending 15 years of returns would be bad, maybe even impossible. But it is RIGHT.

What do people think of just amending 2009, 2008 and put all of the rest on the 2007? I don't know what I think of this idea. I would want to think about it for a couple of days before giving my opinion on it. But maybe this is the best that is possible.

If you put it on the past tax returns, the amount claimed as income would be a "cost basis' when you surrender the policy. I think the amount of the cost basis should be paid from the Plan to the Participant because I see problems with IRA's and cost basis.

That is my 2 cents worth, well maybe one cent.

What do others think?

[Bird]

I guess just answering the question and ignoring what's right, the answer is "no tax ramifications." That is, if you accept that the PS-58s were never reported, and do nothing to correct it, and surrender the policy in the plan and roll over the proceeds along with everything else, then it's all pre-tax money. Of course it's all wrong. I'd think the accountant would know that and it makes me wonder what the real question is - probably "can we get away with it?"

[rcline46]

I always understood that reporting PS 58 was optional, and was done so that the death benefit would be paid tax-free - ie the PS 58 covered the death benefit cost as if paid by the employee. THe result of not paying the PS 58 was that the death benefit would have been taxable.

Since the PS 58 became a cost basis, no PS 58 - no cost basis. Since the insured 'beat the odds' and did not die, I don't think there is any problem at all.

[ombskid]

I always understood that reporting PS 58 was optional, and was done so that the death benefit would be paid tax-free - ie the PS 58 covered the death benefit cost as if paid by the employee. THe result of not paying the PS 58 was that the death benefit would have been taxable.

Since the PS 58 became a cost basis, no PS 58 - no cost basis. Since the insured 'beat the odds' and did not die, I don't think there is any problem at all.

If they had paid tax on the ps-58 cost, and now cashed in the policy except for the amount of the total ps-58 costs, then distributed the policy (with the ps-58's still in it) to the owner, that transfer would be tax free because the ps-58's are considered basis, and the rest of the account can be rolled over, ultimately to be taxed.

If they cash it in now (all of it), it is rolled over and ultimately the whole thing is taxed.

Whether or not it is right, wouldn't the amount taxed be the same?

[rcline46]

Yes the total taxed would be the same, only timing on the taxes. I see no problem with cashing the policy and rolling over the entire amount with no basis.