Bank‑Owned Life Insurance Tax Treatment: A Clear Guide for Policyholders

What Is Bank‑Owned Life Insurance?

Bank‑owned life insurance (BOLI) is a corporate life insurance policy purchased by a bank for its employees. The bank is the policy owner, while employees may be the insured. The bank pays the premiums and receives the death benefit, which is usually tax‑free to the bank and can be used for various corporate purposes.

Key Tax Rules for BOLI

The tax treatment of BOLI is governed by the Internal Revenue Code (IRC) and IRS regulations. The main points are:

• Premiums: Generally deductible as a business expense, but only after the policy's cash value reaches a certain threshold.
• Cash Value Growth: Accumulation is tax‑deferred; no tax is due on gains until the policy is surrendered or the cash value is accessed.
• Policy Loans: Loans against the cash value are not taxable as income, provided the loan amount does not exceed the policy's cash value. Excess loans may be treated as taxable distributions.
• Death Benefit: The death benefit paid to the bank is tax‑free under IRC § 101(a)(2). The bank can use it without incurring income tax.

How Premium Deductibility Works

Under IRC § 162(a)(2), a bank can deduct premiums only if the policy's cash value has grown to at least 10% of the premiums paid during the year. Until that point, premiums are treated as a capital expense and are not deductible.

Cash Value Accumulation and Tax Deferral

Cash value grows at a rate determined by the policy's interest rate or investment performance. The growth is not taxed annually, but it is subject to a 10% excise tax if the bank sells the policy or the policy's cash value is distributed before a specified period.

Policy Loans: Conditions and Limits

Loans are typically interest‑free up to the policy's cash value. If the bank borrows more than the available cash value, the excess amount is considered a taxable distribution. The loan must be repaid with interest; otherwise, the unpaid balance reduces the death benefit.

Implications for Estate Planning

Because the death benefit is tax‑free, banks can use BOLI to fund reserve requirements, capital improvements, or other strategic goals. Employees' beneficiaries receive no direct benefit; the policy is a corporate asset.

Common Misconceptions

1. "BOLI is a personal policy." It is a corporate asset; employees are insured, not owners.

2. "Premiums are always deductible." Deduction is conditional on cash value growth.

3. "Loan interest is always taxable." Interest on policy loans is not taxable as income.

Factual Table: Tax Treatment Summary