AICPA Letter Suggests Changes to Proposed Split-Dollar Regulations

The AICPA has four concerns about the proposed regulations (REG- 164754-01) relating to split-dollar life insurance, according to its letter to IRS Commissioner Charles O. Rossotti.

Document Type: Public Comments on Regulations

Tax Analysts Document Number: Doc 2002-23894 (7 original pages) [PDF]

Tax Analysts Electronic Citation: 2002 TNT 205-18

Citations: (22 Oct 2002)

=============== SUMMARY ===============

The AICPA has four concerns about the proposed regulations (REG- 164754-01) relating to split-dollar life insurance, according to its letter to IRS Commissioner Charles O. Rossotti.

Those concerns include a lack of clarification of what benefits are subject to taxation by the non-owner employee, a lack of consistent application of rules on granting basis in the insurance contract, a failure to account properly for the cost-sharing between owners and non-owners, and a lack of accounting for repayment of policy loans by non-owners.

The AICPA also believes the definition of "split-dollar arrangement" should be clarified as to whether it refers to the split-dollar arrangement or to the insurance policy; it prefers the former.

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October 22, 2002

The Honorable Charles O. Rossotti
Commissioner of internal Revenue
Internal Revenue Service
Courier's Desk
1111 Constitution Avenue, N.W.
Washington, DC 20044

Re: Comments on REG-16475-40, Proposed Regulations Relating to Split-Dollar Life Insurance Arrangements

Dear Commissioner Rossotti:

[1] Enclosed are an original and eight (8) copies of the American Institute of Certified Public Accountants' comments on the above-referenced regulations. The comments were developed by members of the Split-Dollar Task Force and approved by the Tax Executive Committee. We hope they will be helpful as you complete this project.

[2] We would be pleased to meet with you to further discuss our comments regarding the proposed regulations. You may contact Steven J. Leifer at (203) 353-5800 or or Marc A. Hyman, AICPA Technical Manager at (202) 434-9231 or to schedule a meeting or if you have any questions regarding our comments.


Pamela J. Pecarich, Chair
Tax Executive Committee
American Institute of Certified
Public Accountants
New York, NY

cc: Elizabeth Kaye, IRS Attorney, ITA
Erinn M. Madden, IRS Attorney, Executive Compensation, TEGE
Krishna Vallabhaneni, IRS Attorney, Corporate
Rebecca Asta, IRS Attorney, FIP
Lane Damazo, IRS Attorney, PSI
Pamela Olson, Treasury Assistant Secretary -- Tax Policy
David W. Brazell, Financial Economist, Treasury
Lon B. Smith, Associate Chief Counsel (FIP)
David B. Silber, Assistant to Branch Chief, FIP-2
Bob Misner, Senior Technical Reviewer, Executive Compensation, TEGE
Lindy L. Paull, Chief of Staff, JCT


Comments on Proposed Regulations [REG-164754-01]
Regarding the Tax Treatment of
Split-Dollar Life Insurance Arrangements

Approved by the


Split-Dollar Task Force

Steven J. Leifer, Chair
John C. Boma
Robert L. Perez
R. Lee Wirthlin
Marc A. Hyman, AICPA Technical Manager

Submitted to the Internal Revenue Service
October 22, 2001

Executive Summary

[3] The American Institute of Certified Public Accountants is pleased to respond to these proposed split-dollar life insurance regulations. In general, we respect the difficulties inherent in attempting to define each and every instance of economic benefit inuring to the parties in split-dollar life insurance arrangements and in determining rules which would consistently apply general principles of taxation to each instance. Also, we congratulate Treasury for understanding the need for rules grandfathering certain existing arrangements.

[4] However, we are concerned that the proposed rules: (1) fail to clarify what specific benefits would be subject to taxation by the non-owner employee opening up the determination of what are taxable economic benefits to conjecture and subjectivity; (2) fail to consistently apply the rules on granting basis in the insurance contract; (3) fail to account properly for the cost-sharing between owners and non-owners; (4) and fail to account for repayment of policy loans by non-owners.

[5] The term "split-dollar arrangement" should also be defined to clarify whether it refers to the split-dollar agreement or to the insurance policy. The AICPA believes that the term arrangement should refer to the split-dollar agreement. Grandfathering existing "agreements" should be emphasized over grandfathering existing "policies." To promote clarity and, therefore, consistency in application, the final regulations should explicitly list the policy (or other) modifications that would cause existing arrangements to be or not to be grandfathered.

Specific Comments

I. Economic Benefit Plan Issues

A. Measurement of Economic Benefits in Equity Arrangements -- Proposed reg. section 1.61-22(d) requires the owner and non-owner in an equity split dollar life insurance arrangement to account currently for the benefits of the contract. The proposed regulations state, that "any right in, or benefit of a life insurance contract (including, but not limited to an interest in the cash surrender value) provided during a taxable year to a non-owner under a[n equity] split- dollar life insurance arrangement is an economic benefit. . .". See section 1.61-22(d)(3)(i). The proposed regulations fail to define the language "any right in, or benefit of, a life insurance contract . . ." leaving the taxpayer to determine what specific benefits must be valued. The preamble gives a single example in the compensatory context, stating that gross income must include changes in the cash surrender value.

The proposed regulations reserve guidance on the valuation of these economic benefits. The preamble discusses appropriate valuation methodologies and notes that one potential approach would be to subtract the net present value of the amount to be repaid to the owner in the future from the current premium payment. The difference, presumably, would be the value currently transferred to the non-owner. Using the premium actually paid as the basis for valuation has merit.

However, taxing the non-owner employee based on changes in cash surrender value is inconsistent with Treasury's view of split- dollar arrangements. Elsewhere in the preamble, Treasury states that a non-owner's interest in the life insurance contract in an equity split-dollar arrangement is less like that of an employee covered under a nonqualified deferred compensation arrangement and more like that of an employee who obtains an interest in a specific asset of the employer, for example, where the employer makes an outright purchase of a life insurance contract for the benefit of the employee. If the employee is treated as acquiring an interest in the insurance contract, changes in the cash surrender value of the contract should not be reflected in the employee's gross or taxable income, because the employee owns the contract.

B. Basis Attends a Transfer of Value -- Proposed reg. section 1.61-22(f)(2) denies the non-owner basis in the policy in a split-dollar arrangement, even though the non-owner must include in income amounts represented by the value of the policy. The preamble sets forth a rationale for this result stating that one party is treated as the owner of the entire contract. Therefore, no amount paid by the non-owner, whether or not designated as a premium, and no amount included in gross income as an economic benefit, is treated as an investment in the contract.

This treatment is inconsistent with the preamble's stated view of split-dollar arrangements. If Treasury took the view that the employee merely has an expectation or promise that the employer will transfer something of value at a later date, this denial of basis would be arguably appropriate. But if Treasury's view is that the employee is in the position of someone who already has received an interest in a specific asset, then basis in that asset should follow.

Although the proposed regulations provide special rules to reduce the taxable income recognized by the non-owner employee if the contract is transferred to that non-owner, they do not recognize the non-owner's basis in the transferred property, consistent with the view that a transfer has already taken place.

C. Deductibility/Inclusion Parity -- Proposed reg. section 1.61-22(f)(3) provides that any amount paid by the non- owner to the owner is included in the owner's taxable income, rather than serving to reduce the owner's cost for the policy. The owner also is denied a deduction for any amounts paid, except to the extent that the non-owner is taxed under section 83 when the contract is transferred to the non-owner.

Denying a deduction to the owner for any portion of the premium, yet taxing the owner on amounts paid by the non-owner which serve to reduce the owner's nondeductible cost is clearly inconsistent. Characterizing as taxable income amounts which represent a sharing of costs, or a contribution towards the cost of the insurance contract, results in the owner recognizing income for a recovery of its own funds. If the owner's premium payments were deductible, such a recovery into taxable income could be justified. Treating the non-deductible amounts paid by the non-owner as taxable income to the owner is incorrect.

D. Policy Loans Should Be Nontaxable -- Section 1.61- 22(e)(1) mandates that "specified policy loans" be included in taxable income by the non-owner. Specified policy loans are defined to include a loan where the non-owner's obligation to repay "is capable of being satisfied" by repayment to the insurance company by the owner or non-owner. Thus, in the employment context, a non-owner employee would be taxed on amounts he or she receives and, in fact, repays.

This result is clearly inconsistent with taxing the non-owner currently based on transfers of value that the proposed regulations deem to have occurred. Because the regulations treat the employee as having received an interest in a specific asset, further taxation on the basis of borrowing against that asset where the employee is liable for repayment is not warranted.

Policy loans generally are not subject to tax. In order to find loans to the non-owner employees taxable, the regulations treat the loan as if it had been made to the owner, who then paid such amounts as compensation to the non-owner. If the non-owner is liable for repayment, compensation treatment is incorrect. If at some point it becomes clear that the non-owner is relieved of the repayment obligation, then compensation treatment would be appropriate.

To the extent the proposed regulations treat a loan as constituting a transfer of property to the employee and thus taxable, a compensation deduction to the employer should follow. The regulations should clarify that such a deduction will be allowed.

The proposed regulations treat death proceeds received by the non-owner as excludable under section 101(a) as an amount received under a life insurance contract. Amounts received by the non-owner as a borrowing from the contract should be afforded similar, nontaxable treatment.

E. Economic Rights Should Be Enumerated -- Section 1.61- 22(g) states that on the transfer of a life insurance contract to a non-owner, the amount to be taken into account by the parties is based upon the fair market value of the contract. Proposed reg. section 1.61-22(g)(2) defines fair market value as "the cash surrender value and the value of all other rights under such contract . . . other than the value of current life insurance protection."

Cash surrender value is generally considered to represent the fair market value of a life insurance contract. Referring to "other rights" and suggesting that they can be valued for purposes of determining compensation introduces the possibility that all sorts of intangible conditions incident to the policy can or should be valued. Rather than leaving the question of fair market value open to creative conjecture and interpretation, the final regulations should enumerate the specific rights envisioned by the proposed regulations.

F. Good Faith Reporting Should Be Sufficient for Amount of Death Benefit Exclusion -- Proposed reg. section 1.61- 22(f)(2)(ii) provides an exclusion under section 101(a) for amounts received by a beneficiary (other than the owner) by reason of the death of the insured to the extent that (1) such amount is allocated to the non-owner pursuant to a split-dollar arrangement, the cost of which was paid by the non-owner, or (2) "the value of which the non-owner actually took into account pursuant to . . ." the split-dollar regulations.

The proposed regulations imply that the exclusion of the death proceeds is dependent on the non-owner's having taken into account -- i.e., included in taxable income -- the correct amount of the benefit provided, As long as the owner has appropriately reported the split-dollar arrangement, the beneficiary's exclusion should not depend on reporting by the non-owner, over which the beneficiary has little or no control. If the parties report the split-dollar arrangement on their respective tax returns in good faith, the amount to be taken into account by the non-owner should not affect the amount of the death benefit excluded by the beneficiary.

II. Grandfathering Issues

A. Definition of "Grandfathered" -- The term "grandfathered arrangements" should refer to arrangements that are entered into prior to the issuance of final regulations.

B. Definition of "Arrangement" or "Contract" -- The proposed regulations generally define a split-dollar life insurance arrangement as any arrangement: (1) that is not part of a group term life insurance plan described in section 79; (2) between an owner and a non-owner of a life insurance contract; (3) under which either party to the arrangement pays all or part of the premiums; and (4) where one of the parties paying the premiums is entitled to recover (either conditionally or unconditionally) all or any portion of those premiums and such recovery is to be made from, or is secured by, the proceeds of the contract.

This definition is intended to apply broadly and would, for example, cover an arrangement under which the non-owner of a contract provides funds directly to the owner with which the owner pays the premiums, as long as the non-owner is entitled to recover the funds from the contract proceeds (for example, death benefits) or has an interest in the contract securing this right of recovery. In addition, the amount to be recovered by the party paying the premiums need not be determined by reference to the amount of those premiums. This definition excludes insurance contracts in which the only parties to the arrangement are the policy owner and the life insurance company acting only in its capacity as issuer.

However, the regulations do not specify whether the word "arrangement" is defined as the legal contract (the "split- dollar agreement") or the life insurance contract (the "policy"). Because the proposed regulations define an arrangement as "any agreement between an owner of a life insurance contract and non-owner of the contract," the intent appears to be to define "arrangement" as the "split-dollar agreement" and not the "policy" itself. We agree with this intent, but request that it be clarified. Making this distinction is critical for our members who must interpret the regulations when advising clients and during tax return preparation.

The AICPA believes that the split-dollar agreement defines the rights and the ownership of the policy. This is a particularly important distinction for all arrangements entered into prior to the final regulations. The ability of the parties to make changes within a policy without violating the status of the arrangement is critical. Without clarification, a taxpayer who may have to make changes to an existing insurance contract due to carrier insolvency, a takeover or financial downturn, or who may wish to change to a more suitable policy, for example utilizing section 1035, might become subject to the new, final regulations and, therefore, be unduly burdened.

C. Modifications Should be Specifically, Listed -- The regulations would make a significant change in the treatment of split-dollar arrangements. Accordingly, it is very important that taxpayers be able to determine with certainty whether existing arrangements might be subjected to the new rules. In order to avoid confusion and reporting inconsistencies, as well as to provide needed clarity on how to apply the regulations, the final regulations should specifically list the "material modifications" which would cause an arrangement to lose its grandfathered status. For example, a change in the insurer might not be a material modification to an arrangement, which would be grandfathered; however, a change in the insured might be a material modification which would cause the arrangement to be subject to the final regulations.


Code Section: Miscellaneous
Geographic Identifier: United States
Subject Area: Insurance company taxation
Industry Group: Insurance
Cross Reference: For summary of REG-164754-01, see Tax Notes, July 15, 2002, p. 361;
for the full text, see Doc 2002-17108 (24 pages) [PDF], 2002 TNT 135-10 , or
H&D, July 5, 2002, p. 175.
Institutional Author: American Institute of Certified Public Accountants