Do A Year-End Check-Up On Split Dollar Planning
Notice 2001-10 has brought change to split dollar planning. As the year begins to wind down, it is important you review these changes and understand how they impact you and your clients going forward.
Notice 2001-10 primarily focused on measuring economic benefit and taxability of equity split dollar. This article will focus on the impact on various split dollar plan designs and discuss alternatives that are available.
Measuring Economic Benefit. The IRS acknowledged in Notice 2001-10 that the P.S. 58 tables are out of date and inappropriate because they no longer provide a realistic cost of term insurance. The new Interim Table 2001 provides rates that are substantially lower than P.S. 58 rates and are based on the Section 79 group term rates.
See figure 1 for a comparison of the P.S. 58 rates and Interim Table 2001 rates.
In most situations, the new Interim Table wont have much impact initially because substitute rates–the insurer’s published one-year term rates for standard risks–can continue to be used.
It is important to keep in mind, however, that after Dec. 31, 2003 there are additional tests applied to insurers’ substitute term rates:
–The insurer must let applicants for term insurance know about this product;
–The insurer must regularly sell the coverage; and
–The insurer cant commonly sell term insurance to standard risks at higher rates
Taxation of Equity Split Dollar. Under the Notice, Section 7872 (loan treatment) or Section 83 (taxable transfer) may be used. The option selected must be consistent with how the plan is managed and the parties must have followed that arrangement from inception.
Treatment as a Loan or Series of Loans:
–Imputed income on the outstanding premium loan will be taxable to the employee.
–No additional economic benefit will be charged.
–The employee will be treated as the owner of the policy and there will not be a transfer under Section 83 of any of the cash value accruing to the benefit of the employee.
If the employee does not pay off the loan based on the agreement, taxable income will be reported on the loan amount forgiven. Even if these tests are met, there could be additional income tax on distributions based on Internal Revenue Code Section 72 or 7702.
Treatment as a Section 83 Taxable Transfer:
–The economic benefit received by the employee must be fully accounted for.
–The employer is treated as having a beneficial ownership in the policy.