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Fall 2003
Paul Vecchione
Amper Financial Services Group
Two events are critically important when considering split dollar
insurance arrangements. First, regulations governing this method
of financing a life insurance premium became final on September
12, 2003 and affect all arrangements entered into after September
17, 2003. Second, on January 3, 2002, the Internal Revenue Service
issued IRS Notice 2002-8, providing optional transitional rules
for arrangements in existence prior to January 28, 2002 and which
must be acted upon by January 1, 2004. Taxpayers are free to continue
arrangements under old rules, but face potential taxation of equity
at lifetime termination of the arrangement. Following is a brief
overview of the transitional rules and an overly simple summary
of the strategies to consider for plans governed by the final regulations.
Transitional Rules
Two "safe harbor" rules exist for taxpayers with arrangements in
existence prior to January 28, 2002, where a sponsor has made
premium or other payments under the arrangement and has
received or is entitled to receive full repayment of premiums.
Action taken under either of the two rules is intended to protect
the employee's equity from taxation at termination of the
arrangement. The first choice is to terminate the split dollar
arrangement before January 1, 2004. The second choice is to
have the parties treat all previous premium advances (less any
repayments already made) as loans going forward. This
treatment must begin by January 1, 2004. The OID rules of IRC
sections 1271-1275 and the below market loan rules of IRC
section 7872 will apply. Now that final regulations on split dollar
have been issued, those rules should be followed.
Arrangements Governed by Final Regulations
Tax treatment going forward follows one of two regimes:
economic benefit or loan; the regime is (fundamentally)
determined by who "owns" the life insurance contract. Economic
benefit treatment is used when the employer owns the policy, and
loan treatment applies when the employee owns the contract.
The economic benefit regime is very similar to what was known pre-final
regulations as the "endorsement" method. Here, the employer has title ownership
of the policy and by beneficiary designation assigns most of the death benefit to
the employee's personal beneficiary. The "cost," from a tax perspective, is tax paid
by the employee on the "economic benefit" of having the net death benefit payable
to the personal beneficiary.
Since the policy and thus all the cash value belong to the employer, there is no
"employee equity." The new regulations, however, do provide rules in the event
the employee has "current access," defined as a current or future right to policy
cash value, but simplicity and current tax on what may (or may not) become a
future benefit tells us it is best to avoid "current access" or any form of employee
equity in a plan under the "economic benefit" regime.
It is also possible to structure a plan under this regime with tax consequences as
outlined above where the employee or an irrevocable life insurance trust has title
ownership to the policy and retains only the death benefit in excess of the greater
of the employer's premium payments or the policy cash value (formerly known as
"non-equity collateral assignment method").
With the loan regime, the employer treats premium advances as "loans," and to
the extent sufficient interest is paid (at least the applicable federal rate as of the
date the loan is made), the new split dollar regulations need not apply. If no
interest is specified, then the below market loan rules of IRC Sections 7872 and
1271-1274 and the new split dollar regulations will govern the taxation of the
arrangement. To the extent gifts are made, gift tax rules will apply.
Loans can be on either a demand or term basis, and each has different rules. The
final split dollar regulations also outline a "special rule" for certain arrangements:
(1) where the term is measured by the life of the insured, (2) where continuation
is based on the employee's performance of substantial services and (3) gift term
loans. In general, this rule provides for use of either the midterm or long-term
AFR, but applies annual income taxation. For gift term loans, the gift is measured
by OID despite the fact the income tax is applicable annually.
The possibility of substantial changes in the applicable interest rate can make
predictability of the income tax and gift tax consequences of the split dollar
arrangement quite challenging. New rules bring new challenges, but also present
great opportunities. Now is a good time to review any existing split dollar
arrangements you may have and chart out the most effective course of action. For
more information on the intricacies of these new rules, contact Paul Vecchione or
your Amper tax representative.
Securities offered through Securities America, Inc. (Member NASD/SIPC)
Advisory services offered through Securities America Advisors, Inc.
2015 Lincoln Highway, Edison, NJ 08818; 732-287-1000
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