DEFINITION AND USES Split dollar is not an insurance policy. Rather, it is a plan for funding the purchase of life insurance. Under a split-dollar plan, two parties share insurance premium payments, death benefits and cash surrender values. While the parties often are an employer and selected employees, two private individuals may also enter into a split-dollar plan. Before the January IRS notice, a split-dollar life insurance plan deferred taxation to the employee on the yearly accumulation of cash surrender value. In addition, taxes on any gain over basis were not due until the policy terminated. With its new pronouncement, the IRS and Treasury Department say any enrichment an employer gives an employee using split-dollar insurance is generally taxable. This means CPAs who previously helped clients establish tax-favored split-dollar plans may now find the party is over. THE PROPOSED CHANGES The IRS-recommended rule changes focus on the five features that once made split-dollar plans so attractive:
One thing is certain: Employees whose wealth increases as a result of payments made from their employer’s pocket under new split-dollar arrangements may now find the transaction taxed as a loan, a gift or as an IRC section 83 transfer. The fate of existing split-dollar plans is less certain, pending IRS guidance expected later this year. Proper documentation for all split-dollar plans is now more important than ever to ensure the tax authorities treat them the way the taxpayer intends. Equally crucial are the cash flow records for payment of the term policy benefit. These payments can flow between the employer and the insurance company as well as from the employee to the employer or directly to the insurance company. CASE STUDY Don, age 45, is a key executive at privately held Hammock Enterprises, an outdoor furniture manufacturer. Part of Don’s compensation is a $1 million life insurance policy paid for using a split-dollar plan. Annual premiums began at $7,733 of which Hammock paid $7,167 and Don $566. Hammock was to be repaid its portion of the premiums from any death benefits, with the remainder going to Don’s beneficiary. As owner of the policy, Don had designated his wife as beneficiary. If either party terminated the policy before Don’s death, the remaining cash value, less the total premium payments Hammock advanced, would go to Don. Before notice 2001-10, Don received substantial tax-free economic benefits from Hammock’s largess. He was not taxed on Hammock’s premium payments. Nor was he taxed on the policy’s annual cash value build-up. Don, and many executives like him, got what amounted to a free ride. As currently proposed, the IRS changes will tax Don on each of these economic benefits. Solution. Don’s CPA can recommend several alternatives if the proposed changes are not altered by subsequent guidance: 1. Terminate the plan and seek alternative solutions to provide a similar benefit. 2. Revise the existing plan by examining Don’s and Hammock’s circumstances to determine the merits of:
3. Amend the plan document and collateral assignment to properly reflect the employer’s intent. It remains unclear whether the IRS will grandfather existing plans. If it does not, Don and Hammock can presumably cancel the plan and policy, create a new plan and purchase another policy conforming to the new rules. 4. If Don and his employer want the split-dollar plan to be treated as a loan, it must meet these tests:
If Don and his employer follow these steps, it appears the one remaining economic benefit will be a change in the cost of term insurance, as it appears in table 2001. WHAT TO DO NOW The interim IRS guidance requires practitioners to examine clients’ split-dollar plans to determine if there is a better way to accomplish the same mission. We advise CPA firms to compile a list of clients that have split-dollar plans. This includes clients with
CPAs should advise
these clients of the IRS notice and compute the tax effects
to them under the interim rules. Then the CPA and client can
sit down and decide what changes, if any, should be made to
the split-dollar plan to minimize the effect of the new
rules. CPAs should also keep an eye out for any final
guidance the IRS may issue as a result of the comments it
received on notice 2001-10. Neil Alexander, CFP, is founder and president of Alexander Capital Consulting, LLC, in Los Angeles. His e-mail address is nalex@alexcap.com . |
or more than four decades, split-dollar plans
have been a popular way to fund employee insurance benefits,
deferred compensation, business succession and family wealth
transfer. Earlier this year, however, the IRS issued notice
2001-10. It indicates the IRS and the Treasury Department
are reviewing the federal income tax treatment of
split-dollar arrangements. The notice also “clarifies” prior
IRS rulings and provides taxpayers with “interim” guidance
they can follow until further guidance is published. These
are the first changes to the split-dollar rules in 25 years
and they will have a significant impact on how clients use
this technique. 
Below-market-rate loans. When the
employee is the beneficial owner of the policy from the
beginning, it’s reasonably likely the employer will be
repaid its premiums from the death benefits. Under these
circumstances, the notice treats employer premium payments
as below-market-rate loans that must carry imputed interest
to the employee. 
