CERTIFIED PUBLIC ACCOUNTANTS AND ADVISORS |
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IRS AGAIN SPLITS
ON SPLIT-DOLLAR ARRANGEMENTS A year following its surprise notice instituting tougher
tax rules on increasingly popular equity split-dollar life insurance
arrangements, the Internal Revenue Service has issued new interim guidance that
revise its 2001 notice. Stiffer taxes on these arrangements are still likely
once final rules are issued, but the interim rules provide added time for users
of these arrangements to huddle with their financial planners to plan ways to
minimize the impact. In early 2001, the IRS issued Notice 2001-10, aimed
squarely at equity split-dollar arrangements. These arrangements are especially
popular with companies and their executives, and with small-business owners for
either buy-sell agreements or to provide cash to pay estate taxes. There are
many variations of split dollar, but in a typical arrangement under the old
rules, the employee might pay a portion of the premium for a whole life policy
equivalent to the premiums for a similarly valued term life policy (determined
by the IRS’s Table P.S. 58). If the employee pays less than the P.S. 58 table
amount, the employee is taxed on the difference. The employer pays the remaining portion of the premium, but
this portion is eventually repaid out of the cash value at the insured’s
termination, retirement or death. Any remaining cash value goes to the employee
(and the death benefits, of course, go to the beneficiary). In short, the
executive or business owner receives an interest-free loan from the company,
garners potentially substantial investment gains and buys life insurance at a
reduced cost. The 2001 notice hit users hard when it announced that the
tax-deferred cash-value gains would be taxed when the policy is “rolled
out,” which is the point when policy repays the employer’s premium payments,
versus waiting until the employee’s death. The result would be huge tax bills
for some employees, including for arrangements already in existence, without the
death benefits available to pay for it. The new notice (2002-08) softens the blow. First, it’s
important to understand that policy ownership becomes a crucial factor. With the
endorsement method, the employer owns the policy along with all equity in the
policy, though ownership of such policies can be transferred later to the
employee. If the policy is transferred to the employee under the proposed rules,
the cash value in excess of the employee’s contributions is taxed to the
employee. Under the far more common collateral assignment method, the
employee or business owner owns the policy. If the insured is expected to repay
the company, then the money provided by the employer is considered a series of
loans and the employee owes taxes on the imputed interest. In cases where the
employee is not obligated to pay back the premium loans, the loans are treated
as compensation to the employee. A real break falls for arrangements made before January 28,
2002. By either terminating the arrangement and paying back the employer or
converting the arrangement to an interest-free loan before January 1, 2004, all
policy equity accrued before January 1, 2004 escapes taxation. Policies
terminated after the January 1 date will face taxation on the equity at the
rollout date. The January 1, 2004 date should give parties time to consult with
their financial advisors to see whether it’s worth revamping their
split-dollar arrangement. The 2001 and 2002 notices also replaced the outdated P.S.
58 table with a 2001 table. The table more accurately reflects longer life
expectancies and has the effect of shrinking the premium payment. The new rules also allow split-dollar plans created before
January 28, 2002, the option of using the old P.S. 58 rates or the new 2001
rates. Plans created on January 28 or after will use the new 2001 table until
final regulations are published or an insurer’s “generally available” and
“regularly sold” term rates. As complex as split-dollar arrangements are, and with some
questions remaining unanswered until final regulations are published, business
owners and employers will want to consult closely with their financial advisors.
For one thing, until final regulations are published, taxpayers can rely on
either older Notice 2002-10 or the newer notice. July 2002— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by McGuire & Co., LLP, a local member in good standing of the FPA. |
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