Even today, when a COLI plan's death benefits are paid to an employee's family directly, the company paying the premiums can deduct them from corporate profits and earnings.
The Internal Revenue Service (IRS), via the Supreme Court case Knetsch v. United States (1960), had early success in challenging the bona fides of these types of arrangements as creating legitimate debt and interest eligible to be deducted.
Although the 4 out of 7 test was exploited in the 1980s by businesses seeking to in effect pay for insurance on employees/shareholders, e.g., on a deductible basis, the introduction of the US$50,000 cap/insured in 1986 in turn led to the creation of broad-based leveraged COLI transactions, i.e., those in which the employer would purchase life insurance on hundreds or thousands of (usually low-level) employees, that would produce tax savings on interest deductions in excess of the actual cost to the employer of engaging in the transaction.
Ultimately, the IRS won court cases against several leveraged COLI investors, including Camelot Music, Winn-Dixie, American Electric Power, and Dow Chemical.
So long as the employer complies with the new rules (adopted in 2006 and characterized as the "COLI Best Practices Act"), however, the tax-free nature of the death benefits and the tax deferral on earnings credited to policy value remain.
Notice and Consent Requirements According to one source,[3] Hartford Life Insurance estimated that one-quarter of all Fortune 500 companies have COLI policies, which cover the lives of about 5 million employees.