Here's LISI's first look at
the just released final split-dollar regs.
This is Part I. Part II will be in your e-mail by the time you finish
reading this. LISI's Actual Text (Keeping
Current) tab will lead you to the actual text of the final regulations and
accompanying Revenue Ruling.
On Thursday, September 11th, The IRS and Treasury jointly released final
split dollar regulations, officially TD 9092 and titled Split-Dollar Life
These regulations are designed to provide guidance to persons who enter
into split-dollar life insurance arrangements and cover income, employment,
and gift taxation aspects.
EFFECTIVE: These rules apply to any split-dollar life insurance
arrangement entered into after September
17, 2003. So go back and study IRS Notice 2002-8 because it
will be your primary source of guidance for split-dollar arrangements
entered into prior to January 28, 2002 (which as Lee Slavutin
reminded me is hopefully most or all of our split-dollared
To illustrate the sense of humor of the Service and Treasury, not only
do they release this bomb on 9/11 on my birthday and one day before
Charlie Ratner was scheduled to go on vacation -
but they provide the following statement under the side-splitting title,
Paperwork Reduction Act,
"The estimated annual
burden per respondent varies from 15 minutes to 30 minutes, depending on
individual circumstances, with an estimated average of 17 minutes."
So much for the dark (if unintended) humor. On with the show!
The final regulations do not address the possible application of section
402 of the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley), Public Law 107-204, to all or certain
split-dollar life insurance arrangements entered into by companies subject
to Sarbanes-Oxley. The position of the IRS and
Treasury is that "interpretation and administration of Sarbanes-Oxley fall within the jurisdiction of the
Securities and Exchange Commission."
Having disposed of that, let's move to the main act:
THE PAST IS YOUR GUIDE TO THE FUTURE:
99 PERCENT OF THE FINAL
REGULATIONS IS TAKEN VERBATIM FROM THE TWO SETS OF PROPOSED REGS. SO I'M
GOING TO REVIEW THEM FIRST.
2002 PROPOSED REGS: July
9, 2002, the Treasury and Service issued proposed regulations
(REG16475401) that contained comprehensive rules for the income, gift,
employment, and self-employment taxation of equity and non-equity
split-dollar life insurance arrangements.
These 2002 proposed regulations set the stage and are largely followed
in the final regulations. I strongly suggest you obtain a copy of two
articles, both from Estate Planning Magazine: "Proposed Regs on Split-Dollar Impose Tax on Shifts of
Wealth" (November 2002, Vol. 29, No. 11, Pg. 547) and "Planning
for Split-Dollar Under the Latest Prop. Regs: 20
Questions". (Best bet if you don't subscribe to Estate Planning is a
good law library or call 800 828 7571 and ask for the Back Issue
DEFINED: The regulations, both proposed and final, define split-dollar
as an arrangement between two or more parties to allocate the policy
benefits and, in some cases, the costs of a life insurance contract.
EQUITY SPLIT-DOLLAR DEFINED: An equity split-dollar life
insurance arrangement is defined as one in which one party to the arrangement
typically receives an interest in the policy cash value (or equity) of the
life insurance contract disproportionate to that party's share of policy
premiums. In other words one party less more than his/her/its share and the
other party pays more. The party that pays less than his/her/its share also
typically receives the benefit of current life insurance protection under
DOLLAR DEFINED: A non-equity split-dollar life insurance arrangement
exists where one party typically provides the other party with current life
insurance protection but not any interest in the policy cash value.
TWO MUTUALLY EXCLUSIVE REGIMES: The 2002 proposed regulations
provide two mutually exclusive regimes for taxation of split-dollar life
insurance arrangements. The first is a loan regime. The second is an
economic benefit regime.
Loan Regime: Under the loan regime , the
non-owner of the life insurance contract is treated as loaning the amount
of its premium payments to the owner of the contract. If the transaction
takes the form of a collateral assignment (the legal owner assigns the
policy as collateral for the advances of the other party), the loan regime
generally governs the taxation of the arrangement.
Economic Benefit Regime: Under the economic benefit regime the
owner of the life insurance contract is treated as providing economic
benefits to the non-owner of the contract. If the arrangement takes the
form of an endorsement (e.g. the corporation ("owner) advances the
money but allows the insured-covered employee (non-owner) to name the death
benefit by endorsement of the contract), generally, the economic benefit
regime governs the taxation. The 2002 proposed regulations
"reserved" on the rules for valuing economic benefits provided to
the non-owner under an equity split-dollar life insurance arrangement
governed by the economic benefit regime, pending receipt of comments from
interested parties. Simply put, all bets were off until the IRS and
Treasury were ready to state how the economic benefits the
"non-owner" received would be valued.
2003 PROPOSED REGS:
On May 9, 2003, the
IRS and Treasury issued REG16475401, a second and different proposed
regulation. This proposed regulation, the 2003 proposed regulation, covers
the taxation under an equity split-dollar life insurance arrangement
governed by the economic benefit regime.
VALUATION OF ECONOMIC BENEFITS: In a nutshell, the 2003
proposed regulations provide that, in the case of an equity split-dollar
life insurance arrangement, the value of the economic benefits provided to
the non-owner under the arrangement for a taxable year equals the sum of:
(1) the cost of any current life insurance protection provided to the
(2) the amount of policy cash value to which the non-owner has current
access (to the extent that such amount was not actually taken into account
for a prior taxable year), and
(3) the value of any other economic benefits
provided to the non-owner (to the extent not actually taken into account
for a prior taxable year).
FINAL REGS A FIRST LOOK OVERVIEW: Essentially, the final
regulations adopt with few exceptions - the 2002 and 2003 proposed
regulations described above. The Treasury and Service made only minor
changes and made it clear the were sticking with
their strong and strident position.
Here are those exceptions in the form of "amendments".
SPLIT DOLLAR INSURANCE ARRANGEMENT DEFINED: A split-dollar life
insurance arrangement is generally "any arrangement between an owner
of a life insurance contract and a non-owner of the contract under which
either party to the arrangement pays all or part of the premiums, and 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
Exception for Policy owners and Insurers: If the only parties to
the arrangement are the policy owner and the life insurance company acting
only in its capacity as issuer of the contract, that an arrangement would
fall outside the definition of a split-dollar arrangement.
Exception for Performance of Services and Shareholders: Certain
arrangements entered into either (a) in connection with the performance of
services or (b) between a corporation and another person in that person's
capacity as a shareholder in the corporation will be considered
split-dollar life insurance arrangements even if they might otherwise not
meet the general definition of a split-dollar life insurance arrangement.
Exception for Key Employee Coverage: True key employee coverage,
under which a company purchases a life insurance contract to insure the
life of a "key" employee or shareholder, will not be considered a
split-dollar arrangement under either the general rule or any of the
special rules - if the employer retains all the rights and benefits of the
contract (including the rights to all death benefits and cash value).
PLAY NO GAMES RULE: To make absolutely positively sure that no
one tries to play games by inappropriately structuring contracts to avoid
the application of these regulations (for instance by using separate life
insurance contracts that are, in substance, one life insurance contract),
the regulations remind us that the IRS has "existing authority"
to challenge such ploys.
TWO MUTUALLY EXCLUSIVE REGIMES:
The two mutually exclusive regimes an economic benefit regime and a
loan regime are retained under the final regulations for determining the
tax treatment of split-dollar life insurance arrangements.
Ownership Rules: Generally, the ownership (e.g. is it the
corporation or the insured-covered employee) of the policy will be the
primary determinate as to which regime applies. The Regulations take the
position that taxpayers can in essence elect which regime (loan or economic
benefit) will apply to their split-dollar life insurance arrangements by
their selection of one party or the other as the contract owner.
Special Rule: When the employer, service recipient, or donor is
the owner of the insurance contract, the economic benefit regime applies.
Additionally, it is applied to a split-dollar life insurance arrangement if
the arrangement is entered into in connection with the performance of
services, and the employee or service provider is not the owner of the life
insurance contract; or the arrangement is entered into between a donor and
a donee (for example, a life insurance trust) and
the donee is not the owner of the life insurance
Special Rule: A special rule applies when payments under the
arrangement had been treated, prior to transfer, as split-dollar loans
under Section 1.7872-15 and the contract is transferred from an owner to a
non-owner. Under this rule, the economic benefit regime applies to the
split-dollar life insurance arrangement from the date of the transfer and
the payments made (both before and after the transfer) are not treated as
split-dollar loans on or after the date of the transfer. The transferor of
the life insurance contract must fully take into account all economic
benefits provided under the split-dollar life insurance arrangement.
OWNERS AND NON-OWNERS:
One person owner: Under the final regulations, the owner
generally is the person named as the policy owner. The IRS reasoning here
is that it is reasonable to determine tax ownership based on who is the
named owner of the policy because (a) the division of the burdens and
benefits of the life insurance contract vary widely in split-dollar life
insurance arrangements, (b) because title ownership generally is a factor
in determining tax ownership, and (c) because this rule provides a clear
objective standard so that both taxpayers and the IRS can readily determine
which regime applies.
Two or more owners: If two or more persons are designated as the
policy owners, the first-named person generally is treated as the owner of
the entire contract.
Exception: If two or more persons are named as policy owners and
each person has, at all times, all the incidents of ownership with respect
to an " undivided interest " in the
contract, those persons are treated as owners of separate contracts for
purposes of these regulations. An undivided interest is defined as an
identical fractional or percentage interest or share in each right, benefit,
and obligation with respect to the contract.
Example: Assume an employer and an employee own a life insurance
contract and share equally in all rights, benefits and obligations under
the contract. As noted above, they will be treated as each owning a
separate contract. Although, ordinarily neither contract would be treated
as part of a split-dollar life insurance arrangement, if the employer and
the employee agree to enter into a split-dollar life insurance arrangement
with respect to what otherwise would have been treated as the employer's
(or the employee's) separate contract, the purported undivided interests
will be disregarded, and the entire arrangement will be treated as a
split-dollar life insurance arrangement.
Facts and Circumstances Testing: The IRS will consider all of the
facts and circumstances of an arrangement to determine whether the parties
have appropriately characterized the arrangement as one involving undivided
interests and, therefore, not subject to these regulations.
Attribution Rules: The final regulations provide attribution
rules for compensatory split-dollar life insurance arrangements. They work
The employer or service recipient will be treated as the owner of the
life insurance contract if the contract is owned by
(1) a member of the employer's " controlled group ",
(2) a Section 403(b) " secular " trust,
(3) a grantor trust (including a rabbi trust) treated as owned by the
(4) a Section 419(e)(1) welfare benefit fund.
NON-EQUITY SPLIT DOLLAR INSURANCE ARRANGEMENTS:
Economic Benefit Regime Governs: Non-equity arrangements entered
into in a compensatory context or a gift context will be subject to the
economic benefit regime.
Subsequent Modification: For purposes of these rules, the
replacement of a non-equity arrangement with a successor equity arrangement
will be treated as a modification of the non-equity arrangement.
(a) If the parties subsequently modify the arrangement so that it is no
longer a non-equity arrangement, and if, immediately after the
modification, the employer, service recipient, or donor IS the owner of the
life insurance contract (determined without regard to the special rule for
non-equity arrangements), the employer, service recipient, or donor
continues to be treated as the owner of the life insurance contract. The
result? The normal rules of the economic benefit regime for equity
split-dollar life insurance arrangements apply.
(b) If, immediately after the modification, the employer, service
recipient, or donor IS NOT the owner, the employer, service recipient, or
donor is treated as having made a transfer of the contract to the employee,
service provider, or donee as of the date of the
TAXATION UNDER THE ECONOMIC BENEFIT REGIME:
Generally: The final regulations provide (essentially the same as
the 2002 and 2003 proposed regulations) that, for these arrangements,
(1) the owner of the life insurance contract is treated as providing
economic benefits to the non-owner of the contract, and
(2) those economic benefits must be accounted for fully and consistently
by both the owner and the non-owner, and
(3) The value of the economic benefits, reduced by any consideration
paid by the non-owner to the owner, is treated as provided from the owner
to the non-owner.
Relationship Governs: The tax consequences of the provision of
economic benefits will depend on the relationship between the owner and the
non-owner. This means when one party provides an economic benefit for
another, it may be treated as:
(1) Payment of compensation,
(2) A dividend under Code Section 301,
(3) A capital contribution,
(4) A gift,
(5) A transfer having a different tax character.
The parties must account for any benefit provided based on its
Example: Assume an employer provides an employee with economic
benefits under a split-dollar life insurance arrangement. The employee must
report the benefits received as compensation on the employee's Federal
income tax return for the year in which the benefits are provided. The
employer would report the transaction by recording them on the appropriate
employment tax and information returns.
Example: Suppose a donor provides economic benefits to an
irrevocable life insurance trust through a split-dollar life insurance
arrangement. The donor would take those economic benefits into account by
reporting them on the Federal gift tax return the donor is required to
file. The trust would not be required to take any action because those
economic benefits would be excludable from gross income under Code Section
HOW NON-EQUITY SPLIT
DOLLAR LIFE INSURANCE ARRANGEMENTS ARE TAXED:
General Rule: The final regulations adopt the familiar tax
treatment of a non-equity split-dollar arrangement under Rev. Rul. 64-328 and its progeny.
Timing of current protection valuation: Subject to an anti-abuse
rule, current life insurance protection is determined on the last day of
the non-owner's taxable year unless the parties agree to use the policy
anniversary date. The anti-abuse rule is designed to prevent the parties
from manipulating the policy cash value for purposes of determining the
value of the economic benefit that the non-owner must take into account.
The rule also extends to the value of the current life insurance
protection. Taxpayers may change the valuation date with the consent of the
It is important to understand how the Treasury and IRS came to its
conclusions with respect to the taxation of an equity build-up: They deny
that the equity should be income tax free to the non-owner. The rationale
adopted in the final regulations is that
"The tax-deferred inside
build-up provided by section 72(e) properly applies only to the taxpayer
that owns the life insurance contract.
If the owner of the contract
provides any of the rights or benefits under the contract to another
taxpayer, that provision of rights and benefits is subject to tax under the
rules that otherwise follow from the relationship between the parties.
For example, this result
applies whenever an employer that owns a life insurance contract
compensates an employee by giving the employee rights to the policy cash
value. In that case, the employer (as the owner of the contract) enjoys
tax-deferred inside build-up under section 72(e), but the employee has
gross income under section 61(a)(1) equal to the
value of the economic benefit attributable to the employee's rights to the
policy cash value. Thus, the regulations are consistent with section 72(e)."
The IRS and Treasury rejected a section 83 approach because Section 83
applies only in connection with a transfer of property, but a non-owner may
have currently includible income by reason of another rule such as the
doctrines of constructive receipt, cash equivalence, or economic benefit.
It was considered "inappropriate to limit current taxation to
circumstances that constitute transfers of property under section 83, and
it would be inappropriate in this context to apply section 83 to circumstances
that give rise to income under other Code provisions or judicial
Here's how the value of the economic benefits provided by the owner to
the non-owner for a taxable year is measured under the final regulations:
It's the sum of
(1) The cost of any current life insurance protection provided to the
(2) the amount of policy cash value to which the non-owner has "
current access "(to the extent that such amount was not actually taken
into account for a prior taxable year), and
(3) the value of any other economic benefits
provided to the non-owner (to the extent not actually taken into account
for a prior taxable year).
Full and Consistent Accounting Required: The owner and the
non-owner also must account fully and consistently for any right in, or
benefit of, a life insurance contract provided to the non-owner under an
equity split-dollar life insurance arrangement. This makes it clear that,
no matter what a benefit is called or what form it takes, its value must be
taken into account and properly reported by the parties.
The Concept of Access: The final regulations provide that the
non-owner has current access to any portion of the policy cash value to
which the non-owner has a current or future right and that currently is - directly
or indirectly -
(a) accessible by the non-owner,
(b) inaccessible to the owner, or
(c) inaccessible to the owner's general creditors.
Impact on True Non-Equity Arrangements: Since the non-owner
under the rules stated above is considered to have current access to
policy cash value only if, under the arrangement, the non-owner has a
current or future right to policy cash value; in a true non-equity
arrangement, the non-owner will have no such right and therefore not be
taxable with respect to the cash value.
Impact of Restrictions on Owner's Creditors' Rights: If the
non-owner has any of the access rights described above, any restriction on
the owner's creditors to reach policy cash value, whether established by
contract or by local law, results in an economic benefit to the non-owner.
According to the Treasury and IRS, this follows the economic reality of an
equity split-dollar life insurance arrangement, i.e., if the owner commits
funds to a life insurance contract and promisses
it will not withdraw those funds, the amounts so committed are no longer a
general asset of the owner since the owner has parted with the ownership
and use of the funds for the benefit of the non-owner.
Broad Construction of Term " Access
": The access concept will be broadly construed. It includes any
direct or indirect right under the arrangement allowing the non-owner to
obtain, use, or realize potential economic value from the policy cash
Example: A non-owner is deemed to have access to policy cash
values if he/she/it can directly or indirectly (1) make a withdrawal from
the policy, (2) borrow from the policy, or (3) effect
a total or partial surrender of the policy.
Example: A non-owner is deemed to have access to policy cash
values if the non-owner can (1) anticipate, (2) assign (either at law or in
equity), (3) alienate, (4) pledge, or (5) encumber the policy cash value or
(5) if the policy cash value is available to the non-owner's creditors by
attachment, garnishment, levy, execution, or other legal or equitable
When the Owner Is Deemed to Have NO Access: The final regulations
consider policy cash value to be inaccessible to the owner if the owner
does not have the full rights to policy cash value normally held by an
owner of a life insurance contract.
When Owner's Creditors are Deemed to Have NO Access: Policy cash
value is deemed to be inaccessible to the owner's general creditors if,
under the terms of the split-dollar life insurance arrangement or by
operation of law or any contractual undertaking, the creditors cannot, for
any reason, effectively reach the policy cash value in the event of the
Special Acceleration Rule: In certain cases, a separate tax rule
may require a non-owner to include an amount in gross income under an
equity split-dollar life insurance arrangement at a time earlier than would
be required under these regulations. This may constitute a tax trap for the
Example: Code Section 457(f) generally
requires an employee of a tax-exempt organization (other than a church
organization or of a state or local government to include deferred
compensation in gross income when the employee's rights to the deferred compensation
are not subject to a substantial risk of forfeiture.
According to the final regulations, an equity split-dollar life insurance
arrangement governed by the economic benefit regime constitutes a deferred
compensation arrangement. Accordingly, an employee of a tax-exempt
organization or of a state or local government may have to include an
amount in gross income attributable to an equity split-dollar life
insurance arrangement even if the employee does not have current access to
the policy cash value under these regulations.
OTHER TAX CONSEQUENCES:
Non-Owner Has No Investment In Contract: A non-owner has no
investment in the contract under Code Section 72(e) prior to a transfer of
the contract. The Treasury/IRS rationale is that only one person is
generally treated as the owner of the life insurance contract and, since
only the owner of a life insurance contract can have an investment in that
contract, a non-owner employee cannot have basis in the contract for any of
the costs of current life insurance protection.
Nor can the non-owner include such costs in the non-owner's basis or
investment in the contract if and when the non-owner becomes the owner of
the contract. The rationale for this is that, because those payments were
made for annual life insurance protection and that protection was
exhausted prior to the non-owner's acquisition of the contract there's
nothing to add to basis.
Inclusion in Owner's Income Required: Any amount paid by the
non-owner to the owner for any economic benefit must be reported in the
owner's gross income. The fact that the split-dollar life insurance
arrangement may require the non-owner to reimburse the owner for the cost
of the death benefit protection provided to the non-owner does not mean
that such payment is not income to the owner. The rationale? The owner is
"renting" out part of the benefit of the life insurance contract
to the non-owner for consideration and that consideration constitutes
income to the owner.
HOPE THIS HELPS YOU HELP OTHERS
Copyright LISI (Leimberg Information Services,
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Steve Leimberg's Estate Planning Newsletter
To be continued in Part II to