Those readers looking for final answers and black and white rules regarding IRS Notice 2002-8, the IRS most recent chapter on the yet unfinished topic of split dollar life insurance, can save their time and skip this article. However, those readers who want to take advantage of the moment and benefit from what I think can best be described as a short-term opportunity should read on.
On Jan. 3, 2002 the Internal Revenue Service issued Notice 2002-8, its long awaited guidance on split dollar life insurance arrangements. This guidance came as a response to the multitude of questions and complaints raised by the insurance industry after the IRS prior guidance, Notice 2001-10.
During January, I had the privilege of listening to many of the industrys leading experts express their views on Notice 2002-8 and the future of split dollar. Not surprisingly, these experts expressed a range of opinions that made it appear as if each had read a separate version of the notice.
But, despite the uncertainty caused by IRS Notice 2002-8, I could not help but think to myself that the notice wasnt really bad news. In fact, I think that there is no time like the present to talk to clients about split dollar.
I think the impact of the notice is best understood if you focus on the three distinct time periods established by the guidance. First, the notice provides a degree of grandfathering for “split dollar arrangements entered into before January 28, 2002.” Second, the notice establishes a regime for split dollar arrangements entered into after Jan. 28, 2002 and “before the date of publication of final regulations.” Dont even ask about arrangements dated January 28!
Third, the IRS hints at the regime that will eventually be adopted for arrangements after the date of final regulations. The notice describes what is expected to be in the “expected proposed regulations” that will be issued by Treasury. These “expected proposed regulations” promise to represent the “permanent” solution to split dollar taxation.
Although this article will touch on the first and third time periods established in the notice, the focus of the article will be on the second time period–today. What can we do now to best serve our clients?
During January, many insurance producers and tax advisors rushed to talk to their clients about split dollar. Time was of the essence as arrangements entered into before Jan. 28, 2002 were promised certain advantages that will not be available for arrangements after that date.
Perhaps the biggest touted benefit for arrangements prior to Jan. 28 is that such arrangements can continue to use the insurance companys cost of annual renewable term insurance for the duration of the arrangement.
Moreover, equity split dollar arrangements entered into before Jan. 28, 2002 can be terminated before Jan. 1, 2004 without any taxation on that portion of the cash value owned by the employer or the employers trust.
As someone who always assumed that the cash value in an equity split dollar arrangement that passed to the employee was taxable–this part of the guidance appears to be a major gift by the IRS and a major victory on the part of the Association for Advanced Life Underwriting, which lobbied hard for “grandfathering” of existing arrangements.
In summary, any agent who has clients with existing “equity” split dollar arrangements should sit down and discuss the notice with those clients well in advance of Jan. 1, 2004. Does it make the most sense to terminate the arrangement before Jan. 1, 2004 and take the cash that has accrued to the employees benefit?
Remember, in an equity split dollar arrangement we are only talking about that portion of the cash value in excess of what has been paid by the employer. Does it make more sense to reclassify the transaction as a loan and continue it past 2003?
Or, because the “low” insurance company alternative term rates have been “grandfathered” for these pre-Jan. 28, 2002 arrangements–maybe it makes the most sense to continue the arrangement past 2004 and not take advantage of the opportunity to remove this “excess” cash value. Obviously, key to this decision is the amount of policy cash value and the age of the insured.
Although some people did get their split dollar arrangements in place by the Jan. 28, 2002 deadline, many did not. That shouldnt come as a surprise to anyone. After all, the IRS chose a cut-off date that was less than a month after the release of Notice 2002-8. And, given the complexity of the notice, that time period that was hardly sufficient to open and close a split dollar case that was not already well under way before the date of the notice.
So, now what do we do for those clients who did not get their arrangements completed by Jan. 28?
In many instances, the best solution for many of your clients remains split dollar. Since we cannot turn back the clock, the best time for split dollar is now. Yes, some flexibility is gone for arrangements entered into after Jan. 28, 2002. But, the interim period after Jan. 28 and before final guidance provides many benefits that probably will not be available after final guidance is issued.
When will final guidance be issued? Since we dont know when final guidance will come, now seems to be the optimal time to act. If your client missed the Jan. 28 deadline, dont let them miss this next one.
For arrangements entered into after the Jan. 28, 2002 deadline and before final guidance (the “interim period”), the cost of term insurance can be measured by the current insurance company annual renewable term rates for the years 2002 and 2003. After 2003, the insurance company annual renewable term rates can only be used to measure the cost of term insurance provided under the split dollar arrangement if the “insurer generally makes the availability of such rates known to persons who apply for term insurance coverageand the insurer regularly sells term insurance at such rates to individuals who apply for term insurance coverage through the insurers normal distribution channels.”
What does that mean? I dont know and nobody else does either. Like many things with split dollar–the meaning of this new requirement will be learned in a future chapter. However, I will note that Blacks Law Dictionary (4th Edition) defines “regularly” as occurring at “fixed and certain intervals.” Being concerned with my health, I get “regular” physical examinations from my doctor–every two years regardless of how I feel.