DOLLAR PROPOSED REGS – TAKE II
OR THE BEGINNING OF THE TEMPEST THAT CRACKED THE TEAPOT?
We’ve asked two real life insurance tax experts, Charles Ratner of Ernst and Young and Howard Zaritsky, Co-Author of Tax Planning With Life Insurance
(800 950 1216) to comment further (Our first commentary on the regs can be found under the ESTATE PLANNING Newsletter
tab, Commentary # 544) on the just released proposed split-dollar regs dealing with equity split dollar in the
You’ll find the actual text of the proposed split dollar regulations ( REG-164754-01 ) by going to http://www.leimbergservices.com
Once logged in, go to RECENT ENTRIES or click on our ActualText
(Keeping Current) tab and drop down to the MORE PROPOSED REGULATIONS ON
EQUITY SPLIT DOLLAR.
CHARLIE RATNER’S COMMENTARY:
Similar to their predecessor proposed regulations that were issued in
July 2002, these new proposed regulations are devoted to the implications
of arrangements that most people have never seen, are not likely to see,
and wouldn’t replicate contractually in any event.
Perhaps the most important things to say about these proposed
regulations are that they
(1) do not address the significant issues facing clients who have
existing split dollar arrangements that might require action before January
2004 under the safe harbors in Notice 2002-8,
(2) should not distract planners and clients from addressing those
crucially important “ticking clock” issues as soon as possible, (See
Charlie’s “Split-Dollar Interruptus” at Trusts
& Estates, April 2003, Vol. 142, No. 4, Pg. 64)
(3) show that the IRS has been doing its homework and is more savvy
about the gamesmanship involved in some of the split dollar designs in the
(4) illustrate the IRS is determined to tax
currently any employee who is enriched by a split dollar plan. Indeed, the
IRS indicates that it will shoot first and ask questions about tax doctrine
The split dollar arrangement addressed by the proposed regulations is
one in which the owner of the policy (typically the employer) permits the
non-owner (typically the insured employee) to
(A) designate by policy endorsement a personal beneficiary for a portion
of the death benefit and
(B) to also have, directly or indirectly, an
interest in the policy cash value (or equity) disproportionate to the
employee’s share of the premium.
Endorsement arrangements are very common, either in their own right or
in conjunction with life insurance-funded nonqualified deferred
compensation. However, these commonly used arrangements typically do not
give the employee an interest in the policy’s cash value and appear not to be
covered by these proposed regulations.
But perhaps the IRS has seen its share of endorsement equity
arrangements and wants to stop them.
EASY TO TRIGGER CURRENT TAXATION!
The examples and analyses offered in these proposed regulations have to
be read carefully to appreciate the full impact of these rules. It seems
that all that is required for annual taxation of the employee’s equity is
that the owner's interest in the policy is stated as the lesser of (a)
premiums paid or (b) cash value upon plan termination of the arrangement.
Clearly, the non-owner is taxed if he can tap the equity during the term
of the arrangement.
But, even if he can't access the equity, it will be taxable because the
equity will not be accessible by the owner when the arrangement is
This is an opera of phantom income!
These proposed regulations are telling in at least three things:
First, they stiffly rebuff the concerns of the planning community
regarding what ought to be taxed, why, and when.
Second, when the IRS/Treasury gets as graphic as to talk about “artifice
or device used to understate the amount of policy cash value to which the
non-owner has current access on the valuation date”, it tells us that they
listen well, read widely, and have a lot of the gamesmanship figured out.
Third, these proposed regulations suggest that one should not infer that
“no inference” means positive inference.
HOWARD ZARITSKY’S COMMENTARY:
In one of the largest disappointments of the proposed regulations, the
Treasury rejected suggestions from several commentators that a non-owner
who includes in income a portion of the policy cash value should be
credited with “inside build-up” on that portion of the policy cash value.
The Treasury stated that, although this treatment might be appropriate if
there were an actual transfer from the owner to the non-owner of the
ownership of the underlying life insurance contract (or part of the
contract), it was not appropriate in an equity split-dollar arrangement,
where no part of the life insurance contract is actually transferred by
reason of the non-owner’s taking policy cash value into account. This
distinction seems strained, at best, and it is more likely that the
Treasury, seeking to maximize taxable income and, thereby, maximize tax
revenues, merely wished not to give the non-owner an additional deemed
investment in the contract, that could ultimately result in a reduction in
the amount of income realized by virtue of the arrangement.
Likewise, the Treasury also refused to allow a non-owner to deduct a
loss, when the cash values of a policy drop from one year to the next, even
though they were taxing the non-owner on increases in cash values from
year-to-year. The Treasury stated that allowing a loss deduction would be
inconsistent with the underlying doctrines of constructive receipt,
economic benefit, and cash equivalence.
The first proposed regs. state
that the non-owner’s investment in the contract under Section 72(e)
includes the amount of economic benefits previously taken into account by
the transferee, when a life insurance contract is transferred from an owner
to a non-owner. Again, the Treasury appears set on concentrating on form
over substance, by drawing artificial distinctions between the treatment of
changes in policy values under a split-dollar arrangement and that of the
actual transfer of the policy.
Those of you who are reading this already understand the importance of
keeping up-to-date with the latest changes. Remember, however, that these
regulations are only proposed. The new terms and conditions for the
taxation of split-dollar life insurance arrangements will not be known
until the Treasury issues final regulations.
Clients contemplating a split-dollar arrangement should enter into it
based on the proposed regulations, because final regulations are not likely
to be more strict or harsh. There is always a remote possibility that the
tax rules for split-dollar arrangements, and particularly equity
split-dollar arrangements, will be eased somewhat in the final regulations.
A client who is willing to establish a split-dollar arrangement under the
rules that the IRS has now proposed, is almost certainly going to be
satisfied with the treatment that is afforded by the final regs.
So, pay attention. Read as much as you can.
But do not get too scared. At least, not yet!
HOPE THIS HELPS YOU HELP OTHERS!
Our thanks to Charlie Ratner and Howard Zaritsky
Steve Leimberg’s Estate Planning Newsletter
Copyright 2003 LISI
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