Rev. Rul. 64-328
1964-2 C.B. 11

 

 

Amplified by Rev. Rul. 78-420
Modified by Notice 2002-8

Full Text

Rev. Rul. 64-328 /1/

Advice has been requested regarding the tax effects of a so-called `split dollar' arrangement between an employer, Y corporation, and its employee, B .

Under the `split dollar' arrangement, the employer and employee join in purchasing an insurance contract, in which there is a substantial investment element, on the life of the employee. The employer provides the funds to pay part of the annual premium to the extent of the increase in the cash surrender value each year, and the employee pays the balance of the annual premium. The employer is entitled to receive, out of the proceeds of the policy, an amount equal to the cash surrender value, or at least a sufficient part thereof to equal the funds it has provided for premium payments. The employee has the right to name the beneficiary of the balance of any proceeds payable by reason of his death. In practical effect, although the employee must pay a substantial part of the first premium, after the first year his share of the premium decreases rapidly, and in some cases it even becomes zero after a relatively few years. He thus obtains valuable insurance protection (decreasing each year, but still substantial for a long time) with a relatively small outlay for premiums in the early years, and at little or no cost to him in later years.

Two major types of `split dollar' arrangements are considered: the endorsement system and the collateral assignment system. In the endorsement system, the employer owns the policy and is responsible for the payment of the annual premiums. The employee is then required to reimburse the employer for his share, if any, of the premiums. Under the collateral assignment system, the employee in form owns the policy and pays the entire premium thereon. The employer in form makes annual loans, without interest (or below the fair rate of interest), to the employee of amounts equal to the yearly increases in the cash surrender value, but not exceeding the annual premiums. The employee executes an assignment of his policy to the employer as collateral security for the loans. The loans are generally payable at the termination of employment or the death of the employee.

A similar problem, involving the endorsement system, was considered in Revenue Ruling 55-713, C.B. 1955-2, 23, wherein it was stated that, in substance, the arrangement is in all essential respects the same as if the employer had made annual loans without interest to the employee, of an amount equal to the annual increases in the cash surrender value of the policies. That ruling concluded that the mere making available of money without interest does not result in taxable income to the payee or a deduction to the payer.

The proper tax treatment of such life insurance arrangements between employers and employees has been reconsidered in the light of the statements in the House and Senate Committee Reports pertaining to the Revenue Act of 1964, Public Law 88-272, C.B. 1964-1 (Part 2), 6, that legislation to provide the proper tax treatment of `split dollar' life insurance arrangements had been deferred because it was believed that `the issues involved in this problem, and the proper solution, including the possibility of administrative action, are in need of further study by the Treasury Department.' H.R. Report No. 749, 88th Congress, C.B. 1964-1 (Part 2), 125, at 186; S. Report No. 830, 88th Congress, C.B. 1964-1 (Part 2), 505, at 582. The problem has been given such further study, and the conclusion has been reached that Revenue Ruling 55-713 incorrectly analyzed the substance of the `split dollar' arrangement in stating that the substance of the arrangement is in all essential respects the same as if the employer incorporation makes annual loans without interest to the employee.

Even if the arrangement is cast under the collateral assignment system, it should not be treated in substance as involving a loan from employer to employee, since generally the employee is not expected to repay the funds provided by the employer except out of the proceeds of the policy or from funds available to the employee by reason of the surrender or loan value of the policy. Instead, the substance is, whether the endorsement or collateral assignment system is used, that the employer provides the funds representing the investment element in the life insurance contract, which would, in arm's length dealings, entitle it to the earnings accruing to that element. The effect of the arrangement for the sharing of the cost of annual life insurance premiums, however, is that the earnings on the investment element in the contract are applied to provide current life insurance protection to the employee from year to year, without cost to the employee, to the extent that the earnings are sufficient to do so.

The table on page 14 illustrates the practical working of the arrangement in the case of an `accelerated ten payment life policy' issued on the life of an employee aged 45, in the face amount of $100,000. (The figures in the first six columns were taken or derived from an actual policy contained in a case before the Internal Revenue Service.)

              Accelerated 10 payment life policy
____________________________________________________________________
        |              |            |    Amount     |              |
Policy  |  Cash value  |   Gross    |   provided    |    Amount    |
 year   |      per     |  premiums  |      by       |   paid by    |
        |   $100,000   |            |  employer, Y  | employee, B  |
        |              |            |               |              |
 (1)    |      (2)     |    (3)     |     (4)       |     (5)      |
________|______________|____________|_______________|______________|
1       |   $7,291.00  |  $7,899.50 |    $7,291.00  |    $608.50   |
2       |   14,775.00  |   7,899.50 |     7,484.00  |     415.50   |
3       |   22,465.00  |   7,899.50 |     7,690.00  |     209.50   |
4       |   30,375.00  |   7,899.50 |     7,899.50  |       0      |
5       |   35,791.00  |   5,268.50 |     5,268.50  |       0      |
6       |   41,356.00  |   5,268.50 |     5,268.50  |       0      |
7       |   47,080.00  |   5,268.50 |     5,268.50  |       0      |
8       |   52,977.00  |   5,268.50 |     5,268.50  |       0      |
9       |   59,062.00  |   5,268.50 |     5,268.50  |       0      |
10      |   65,356.00  |   5,268.50 |     5,268.50  |       0      |
11      |   66,385.00  |       0    |         0     |       0      |
15      |   70,462.00  |       0    |         0     |       0      |
20      |   75,373.00  |       0    |         0     |       0      |
________|______________|____________|_______________|______________|
                                               (continued below)
 
_____________________________________________________________________
        |    Proceeds   |  Cost of  |   Value of     |     Value    |
Policy  |   payable to  | insurance |   insurance    |  provided by |
 year   |  employee B's |    per    |  to employee,  |  employer, Y |
        |  beneficiary  |   $1,000  |  B (6)X(7) /*/ |   (8) - (5)  |
        |               |           |                |              |
 (1)    |      (6)      |    (7)    |      (8)       |      (9)     |
________|_______________|___________|________________|______________|
1       |   $92,709.00  |    $6.30  |     $584.07    |       0      |
2       |    85,225.00  |     6.78  |      577.83    |    $162.33   |
3       |    77,535.00  |     7.32  |      567.56    |     358.06   |
4       |    69,625.00  |     7.89  |      549.34    |     549.34   |
5       |    64,209.00  |     8.53  |      547.70    |     547.70   |
6       |    58,644.00  |     9.22  |      540.70    |     540.70   |
7       |    52,920.00  |     9.97  |      527.61    |     527.61   |
8       |    47,023.00  |    10.79  |      507.38    |     507.38   |
9       |    40,938.00  |    11.69  |      478.57    |     478.57   |
10      |    34,644.00  |    12.67  |      438.94    |     438.94   |
11      |    33,615.00  |    13.74  |      461.87    |     461.87   |
15      |    29,538.00  |    20.73  |      612.32    |     612.32   |
20      |    24,627.00  |    31.51  |      776.00    |     776.00   |
________|_______________|___________|________________|______________|
/*/ The figures in column (8) represent the figures in column (6)
    multiplied by the corresponding figures in column (7) and divided
    by $1,000.

The cost of insurance per $1,000 shown in column (7) is taken from the table contained in Revenue Ruling 55-747, C.B. 1955-2, 228, at page 229. This table reflects 1-year term costs based upon table 38, U.S. Life and Actuarial Tables, and 2 1/2 percent interest.

It is implicit in the illustration, that in each year the `split dollar' arrangement is in effect, the employer allows the annual earnings on the investment element in the policy to provide for the employee, to the extent that they are sufficient to do so, the cost of the current life insurance protection which the employee should bear were the parties to divide the annual premium costs in accordance with their respective interests in the policy, in an arm's length manner where neither party is attempting to confer a benefit upon the other. Taking the third year of the accelerated payment life policy set out in the illustration as an example, the employer pays the annual premium to the extent of the increase in the cash value, $7,690. The employee is obligated to pay only $209.50, although he receives current insurance protection in the $567.56. The employer confers the benefit of the difference between these amounts ($358.06) by in effect allowing earnings on the investment element to be applied in payment of the cost of the employee's current insurance protection. If the parties were to divide the annual premium in accordance with their respective interests in the policy, the employer would pay $7,331.94, and the employee would pay $567.56. Even after the 10-year premium paying period, earnings on the investment element in the contract are used to provide the cost of the employee's insurance protection.

In the typical `split dollar' arrangement, then, the purpose is, and the effect is, to provide an economic benefit to the employee represented by the amount of the annual premium cost that he should bear and of where he is relieved. It is well settled that the providing of life insurance results in an economic benefit to the insured. See, for example, Burnet v. Frederick B. Wells , 289 U.S. 670 (1933), Ct. D. 688, C.B. XII-1, 261 (1933). An employee who receives an economic benefit under an arrangement with his employer generally must include in his gross income the value of the benefit received. Commissioner v. John H. Smith , 324 U.S. 177 (1954), Ct. D. 1633, C.B. 1945, 49; Commissioner v. Philip J. LoBue , 351 U.S. 243 (1956), Ct. D. 1798, C.B. 1956-2, 967. In a situation such as this, in which the economic benefit to the employee is a continuing annual benefit so long as the `split dollar' arrangement is kept in force, the amount to be included annually is the annual value of the benefit received by the employee under the arrangement, which is held to be an amount equal to the 1-year term cost of the declining life insurance protection to which the employee is entitled from year to year, less the portion, if any, provided by the employee. The cost of life insurance protection per $1,000, as shown in the table contained in Revenue Ruling 55-747, supra , may be used to compute the 1-year term cost.

It is further held that the employer is not entitled to any deduction for its share of the annual premiums since it `is directly or indirectly a beneficiary under such policy' within the meaning of section 264(a)(1) of the Internal Revenue Code of 1954. G.C.M. 7997, C.B. IX-1, 210 (1930), Wyoming National Bank of Wilkes-Barre v. Commissioner , B.T.A. Memorandum Opinion entered January 27, 1933. Cf., Omaha Elevator Company v. Commissioner , 6 B.T.A. 817 (1927).

It is further held that the provisions of section 101(a) of the Code apply to the proceeds of the policy payable upon the death of B , both as to the portion received by Y corporation and as to the portion received by the designated beneficiary of B .

The same income tax results obtain if the transaction is cast in some other form resulting in a similar benefit to the employee.

In view of the foregoing, Revenue Ruling 55-713, C.B. 1955-2, 23, is revoked. The revocation is effective as to policies purchased under `split dollar' arrangements or utilized to establish such arrangements after November 13, 1964.

/1/ Also released as Technical Information Release 659, dated Nov. 27, 1964.