On Jan. 29, 2001 the IRS issued Notice 2001-10 in which it announced that changes were on the horizon for split dollar plans, and went on at length about what those changes might be. On Jan. 3, 2002, Notice 2002-8 was released, revoking Notice 2001-10, sort of, and again announcing that changes are on the horizon for split dollar plans.
In 1955 the position of the IRS was that a split dollar arrangement was a form of interest-free loan. In 1964 it took the position that in substance a split dollar arrangement was not a loan, but rather a means by which an employer provides an employee with taxable economic benefits. Over the last three months, rumors of a clash between Treasury and the IRS over which of these theories to apply have been resolved. The answer is both.
Notice 2002-8 promises comprehensive guidance on split dollar in the form of tax regulations. (In the pecking order of tax law, regulations are just below an act of Congress.) Most split dollar rulings have dealt with employer related split dollar arrangements. The new rules promise to address split dollar arrangements between a “sponsor” and a “benefited party.” This should include so-called private split dollar and reverse split dollar.
A long-standing principle of tax law says the substance of an arrangement and not the form controls tax treatment. Ignoring this, the Notice says the treatment of plans where an employer is the formally designated owner (usually the endorsement form) will be different from that accorded to arrangements where the employee is formally designated as the owner (collateral assignment form). Plans of the latter type may be treated as loans.
Conversion from economic benefit treatment to loan treatment has often been viewed as an exit strategy for older split dollar plan participants, who face escalating P.S. 58 costs. Plans entered into before the date of publication of final regulations may convert to loan treatment as long as all net contributions of the plan employer are treated as borrowed on the first day of the year the plan is converted.
Some split dollar plans can be terminated at any time by the employer and are similar to demand loans. As a loan, this type of plan would result in annual imputed income based on an interest rate. Other plans stay in effect until death. Converting a plan of this type to a loan will result in a taxable amount in the year of conversion so substantial that conversion may not be a viable exit strategy.
Most changes will apply to arrangements entered into before date of publication of the final regulations. The value of life insurance protection such arrangements provide may be computed using Table 2001, which was published with Notice 2001-10. And if the plan covers more than one life taxpayers should make “appropriate adjustments” to the rates.
The appropriate adjustment of choice for second-to-die plans will be to multiply the Table 2001 rate for the first life by the probability of death in the current year for the second life, resulting in lower imputed income while both are alive than has been reported up until now.
Arrangements entered into before Jan. 28, 2002 are accorded special treatment. These plans may also continue to determine the value of life insurance protection by using the insurers lower published premium rates that are available to all standard risks for initial issue one-year term insurance.