Business-Owned Life Insurance: How BOLI Works, Taxes, and Form 8925

Business-owned life insurance, commonly called BOLI, is a life insurance policy a company buys on the life of an employee, with the company as both the policy owner and the beneficiary. The company pays the premiums, the cash value grows tax-deferred on its balance sheet, and when the insured employee dies the company collects the death benefit, generally free of federal income tax. Businesses use BOLI as a long-duration asset to offset the cost of employee benefit obligations like deferred compensation and retiree healthcare.

How BOLI Works

The structure is simple. A business applies for a life insurance policy covering a specific employee, pays all premiums from its own funds, and names itself as the sole beneficiary. The employee is the insured person but has no ownership stake, no claim to the cash value, and no direct benefit from the policy during their lifetime.

The policy builds cash surrender value over time, which the company carries as an asset. When the insured employee eventually dies, the company receives a lump-sum death benefit. Coverage can continue for decades and typically stays in force even after the insured retires or leaves the company. The relationship runs strictly between the company and the insurance carrier unless a separate agreement, such as a split-dollar arrangement, changes that.

Which Employees Can Be Insured Tax-Free

Federal tax law restricts which employees a business can insure if it wants the death benefit to remain tax-free. Under 26 U.S.C. § 101(j), the full income tax exclusion for death benefits applies only when the insured falls into specific categories at the time the policy is issued. Getting this wrong means the company could owe tax on the proceeds decades later when the insured dies.

The statute creates several qualifying categories. A director qualifies regardless of compensation. A “highly compensated employee” under 26 U.S.C. § 414(q) qualifies, which includes any 5-percent owner and any employee who earned more than $160,000 in the preceding year (the inflation-adjusted threshold for 2026). A separate category covers “highly compensated individuals,” defined as the top 35 percent of employees ranked by compensation. Officers who are among the five highest-paid also qualify under this group.¹

There is also a broader exception. If the insured employee was an active employee at any point during the 12 months before their death, the death benefit can qualify for the tax exclusion regardless of their compensation level when the policy was issued. That matters for rank-and-file employees who might not otherwise meet the compensation thresholds but who die while still employed.¹

Selecting eligible participants requires a careful review of payroll, ownership, and organizational records. Most businesses work with their insurance carrier and tax counsel to document each insured employee’s qualifying status before submitting applications.

Notice and Consent Before the Policy Is Issued

Even when the insured falls into an eligible category, the death benefit stays tax-free only if the business completed specific notice and consent steps before the policy took effect. This is the compliance step where claims most often fall apart, usually because someone treated it as a formality.

The written notice to the employee must include three things:¹

That the employer is applying for a life insurance policy on the employee’s life.
The maximum face amount for which the employee could be insured at the time the contract is issued.
That the employer will own the policy and be a beneficiary of any death proceeds.

The employee must then sign a written consent agreeing to be insured and acknowledging that coverage may continue after they leave the company. All of this has to happen before the policy is issued.²

If the policy later has a material increase in the death benefit or another material change, the IRS may treat it as a newly issued contract. When that happens, the notice and consent process has to be repeated to preserve the tax exclusion.²

How Premiums, Cash Value, and Death Benefits Are Taxed

BOLI premiums are not deductible. Under 26 U.S.C. § 264, when a business is directly or indirectly a beneficiary of a life insurance policy, it cannot deduct the premiums as a business expense.³ The company pays with after-tax dollars. The tradeoff is that cash value inside the policy grows tax-deferred for as long as the policy stays in force. No annual tax on investment gains, no mark-to-market. Over 20 or 30 years, that compounding is the reason companies buy BOLI in the first place.

The insured employee faces no personal tax consequences. Premiums the employer pays are not treated as taxable compensation, and the employee has no ownership interest that would create a taxable event.

When the insured dies, the company receives the death benefit. Whether that payout is tax-free depends on two conditions: notice and consent were properly completed, and the insured fell into one of the qualifying categories under 26 U.S.C. § 101(j)(2). If both are satisfied, the entire death benefit is excluded from the company’s gross income.¹

If those requirements were not met, the company can still exclude an amount equal to the premiums it paid, but everything above that becomes taxable as ordinary income. At the current 21 percent corporate rate, that turns a significant portion of the death benefit into an unexpected tax bill.²

A separate exception applies when death benefits are paid to the insured’s family members, designated personal beneficiaries, or estate rather than to the company. Amounts used to buy out the deceased employee’s equity interest in the business from their heirs also qualify. These payments can remain tax-free even if the insured did not meet the highly compensated thresholds, as long as notice and consent were properly obtained.¹

What Happens If the Company Surrenders the Policy

BOLI’s tax advantages assume the company holds the policy until the insured dies. Cashing out early triggers a different result. Under 26 U.S.C. § 72(e), when a life insurance policy is fully surrendered, the company must include the gain in gross income. The gain equals the cash surrender value minus the total premiums paid.⁴

Partial withdrawals follow a similar logic. Most BOLI policies are structured as modified endowment contracts, and withdrawals from those come out of the gain first. Even a small withdrawal can be fully taxable until the company has pulled out all the accumulated earnings. Companies considering BOLI should plan to hold the policies long-term and not treat the cash value as a readily accessible reserve.

The Transfer for Value Trap

If a company sells or transfers a BOLI policy to another party for valuable consideration, the death benefit can lose its tax-free status under the transfer for value rule in 26 U.S.C. § 101(a)(2). When the rule applies, the new owner can only exclude an amount equal to what they paid for the policy plus any premiums they pay going forward. The rest of the death benefit is taxable.⁵

Several exceptions preserve the full exclusion. The death benefit stays tax-free if the policy is transferred to the insured employee, to a partner of the insured, to a partnership in which the insured is a partner, or to a corporation in which the insured is a shareholder or officer. Transfers where the new owner’s tax basis carries over from the previous owner, such as in certain corporate reorganizations, are also protected.⁵

This matters most in buy-sell agreements and succession planning, where policies routinely move between owners, partners, or entities. A poorly structured transfer can convert a tax-free death benefit into a six- or seven-figure tax liability.

Account Structures

BOLI policies come in three account structures. The choice affects investment risk, creditor protection, and how quickly the company can access cash value.

General Account

Premiums go into the insurance carrier’s overall investment portfolio alongside its other assets. The carrier typically guarantees a minimum crediting rate, so returns are predictable. The cash value is not legally separated from the insurer’s other obligations, so if the carrier becomes insolvent, general account BOLI is exposed to claims from the carrier’s other creditors. Surrender proceeds can take up to 180 days.

Separate Account

Cash value is held in a distinct account insulated from the carrier’s general creditors. The company chooses from a menu of investment options, and returns fluctuate with market performance. There is no guaranteed minimum rate and the cash value can decline. These policies offer more transparency and allow reallocation among options.

Hybrid

Hybrid policies use separate account investments but may add a stable value wrap from a third-party provider to smooth returns. The assets keep creditor protection because they sit in a separate account, and performance is steadier than a pure variable approach. Surrender proceeds from both hybrid and separate account policies can take up to 365 days to process.

Why Companies Buy BOLI

The most common reason is to informally fund nonqualified deferred compensation plans and supplemental executive retirement plans. Those benefit obligations sit as a growing liability on the balance sheet, and BOLI provides an offsetting asset that roughly tracks future costs.

The tax alignment is the key advantage. The deferred compensation liability produces no current tax deduction. BOLI premiums are likewise not deductible, but cash value grows tax-deferred, matching the deferred tax treatment of the liability. If the executive dies before collecting benefits, the tax-free death benefit can cover the remaining obligation and often more. Benefits consultants frequently recommend BOLI as the funding vehicle for executive benefit programs instead of taxable investments that generate annual income the company would owe tax on while waiting for the liability to come due.

When paired with a rabbi trust, the BOLI assets sit outside management’s direct control, which protects executives against a later change of heart at the top. Rabbi trust assets do, however, remain subject to the claims of the company’s general creditors in bankruptcy.

Banks are the largest category of BOLI purchasers. National banks are authorized to hold BOLI under 12 U.S.C. § 24 and commonly use it to recover the cost of employee benefit programs.⁶ Banking regulators impose additional requirements beyond the tax rules. OCC Bulletin 2004-56 lays out interagency expectations for pre-purchase analysis, board-level approval above capital concentration thresholds, ongoing risk management, and limits on total cash surrender value from any single carrier and from all carriers combined relative to the bank’s capital.⁷

Annual Form 8925 Filing

Any business that owns one or more employer-owned life insurance contracts issued after August 17, 2006 must file IRS Form 8925 each year the policies remain in force. The form attaches to the company’s annual income tax return and reports the number of employees covered and the total insurance in force at the end of the tax year. The company must also indicate whether it obtained valid consent from each covered employee.⁸

Filing is not optional. It is part of the compliance chain that preserves the tax-free treatment of death benefits. If a business fails to file, the IRS can challenge the exclusion and potentially reclassify the death benefit as taxable income when the insured eventually dies. The burden of proof rests on the business to show it provided the required notices, obtained valid consents, and filed the form every year the policies were in force.⁹

The IRS has not issued definitive guidance on specific monetary penalties for late or missing Form 8925 filings. The real exposure is not the filing penalty but the potential loss of the income tax exclusion on death benefits that can be worth millions. Against that risk, the yearly filing is trivial administrative work.

1
Office of the Law Revision Counsel. 26 USC 101 – Certain Death Benefits
2
Internal Revenue Service. Notice 2009-48 Treatment of Certain Employer-Owned Life Insurance Contracts
3
Office of the Law Revision Counsel. 26 USC 264 – Certain Amounts Paid in Connection With Insurance Contracts
4
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
5
Office of the Law Revision Counsel. 26 USC 101 – Certain Death Benefits
6
Office of the Comptroller of the Currency. Bank Owned Life Insurance (BOLI)
7
Office of the Comptroller of the Currency. Bank-Owned Life Insurance: Interagency Statement on the Purchase and Risk Management of Life Insurance
8
Internal Revenue Service. About Form 8925, Report of Employer-Owned Life Insurance Contracts
9
Internal Revenue Service. Form 8925 – Report of Employer-Owned Life Insurance Contracts