Academic journal article Southern Law Journal

Split-Dollar Life Insurance Arrangements: A Tax Minimization Strategy Whose Time Has Returned

Academic journal article Southern Law Journal

Split-Dollar Life Insurance Arrangements: A Tax Minimization Strategy Whose Time Has Returned

Article excerpt

I. Introduction

A split-dollar life insurance arrangement (split-dollar arrangement) is a contract between a donor and a donee who share in the costs and benefits of a life insurance policy.1 Prior to 2003, a split dollar arrangement was a method of dividing the tax and economic benefits of life insurance between a donor and donee and allowing the donor to subsidize the donee's insurance coverage while both avoided tax.2 On September 1 1, 2003, the Internal Revenue Service (IRS or Service) issued final regulations designed to remove the tax benefits taxpayers previously received from investing in a split-dollar arrangement.5 The regulations were supposed to have transformed split-dollar arrangements from vehicles for employee, stockholder, and estate tax avoidance, into vehicles for sharing of life insurance costs that were supposed to be devoid of tax advantages.

The IRS now either taxes the economic benefits received by donees from the donor's payment of insurance premiums, treats the payments as additional income to the donee (economic benefit regime), or treats the donor's premium payments as loans to the donee, imputing the interest to the loans, and taxing the imputed interest as additional income to the donee (loan regime). Even though the parties to the arrangement decide which approach to use, both are supposed to eliminate the tax benefits.4 However, the loan regime continues to provide significant tax savings. Current low interest rates, which are expected to rise in the future, can be used for an insured's life; thus, properly structured splitdollar arrangements under the loan regime still provide attractive tax savings for employees, shareholders, and irrevocable life insurance trusts (ILIT). This paper summarizes the split-dollar arrangement rules, and demonstrates which techniques will provide those tax savings and which arrangements will not.

ii. What Is a Split-Dollar Life Insurance Arrangement?

A. Description of a Split-Dollar Life Insurance Arrangement

A split-dollar arrangement is an interest in a life insurance contract shared by multiple interest holders.5 The arrangement can be between employer and employee, corporation and shareholder, an individual and an ILIT, or any other donor and donee.6 Each contract specifies how the policy premiums are paid and how insurance benefits are shared.

The rules require that a split-dollar arrangement be between one party defined as the policy owner (who may be the party named as owner in the insurance contract or specified by regulation) and a second party (who is designated as the non-owner).7 The parties to the arrangement decide who is designated as the policy owner. The arrangement requires that: (1) the arrangement must be other than a group term life insurance plan8; (2) one or both parties must pay the premiums directly or indirectly; and (3) the payor or payors of the premiums must recover a portion, all or more than all of the payments, from the insurance proceeds.9 For example, an employer and employee may agree to jointly purchase a life insurance policy where the employer pays the cost of the policy and the employee pays income and employment tax each year on the cost of the term insurance portion of the coverage. At policy maturity the employer recovers either an amount equal to the cash surrender value of the policy or the amount of the premiums paid. The insured, the insured's beneficiary, or an ILIT receives the balance of the policy proceeds - cash value above that withdrawn by the employer and any applicable death benefit.10

There are two types of split-dollar arrangement: (1) those owned by the donor, who endorses specified rights to a donee (endorsement arrangement) under the economic benefit regime; and (2) those owned by the donee, who assigns an interest back to the donor (collateral assignment arrangement) under the loan regime. Under an endorsement arrangement the donor owns the split-dollar insurance policy and the donee is taxed on the economic benefits the donee receives. …

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