NU Online News Service, July 8, 3:45 p.m. — Washington

The Internal Revenue Services has proposed a new rule that could cause headaches for users and sellers of equity split-dollar life insurance arrangements, but the proposed rule seems to protect existing split-dollar arrangements.

The rule would affect employers and employees that split the costs and the benefits of owning life insurance policies that insure the employees.

If the rule takes effect, it will split-dollar life arrangements subject to either of two mutually exclusive tax regimes: an economic benefit regime and a loan regime.

Economic Benefit Regime

Under the economic benefit regime, the owner of the life insurance contract would be treated as providing economic benefits to the non-owner, and those benefits would have to be accounted for fully and consistently by both the owner and non-owner.

The value of the economic benefits, reduced by any consideration paid by the non-owner to the owner, would be treated as value transferred from the owner to the non-owner, the IRS says.

The tax consequences of that transfer would depend on the relationship between the two parties.

The IRS could see the transfer as a payment of compensation, a distribution under Section 301 of the tax code or a gift.

Loan Regime

Under the second regime, the loan regime, the non-owner would be treated as lending premium payments to the owner.

This treatment would apply if the payment were made either directly or indirectly by the non-owner to the owner, the payment were a loan under general principles of federal tax law, or if a reasonable person would expect repayment in full, and the repayment would have to be made from, or were secured by, the policy’s death benefit proceeds or its cash surrender value.

If the loan provided for sufficient interest, it would be subject to the general rules for debt instruments, the IRS says.

If the loan did not provide for sufficient interest, it would be treated as a below-market-rate loan.

In general, the IRS says, interest on a split-dollar loan would not be deductible by the borrower.

“Unless the employee is required to pay the employer market-rate interest on the loan, the employee will be taxed on the difference between the market-rate interest and the actual interest,” the IRS says.

Grandfather Clause

The proposed rule would apply to split-dollar arrangements entered into after the proposed rule was published as a final regulation, and to existing arrangements that are “materially modified” after the final publication date, the IRS says.

However, the IRS is seeking comments on whether certain material modifications could be disregarded in determining whether an existing arrangement should be treated as a new arrangement.

At this writing, insurance groups were still analyzing the proposed rule.

The text is available on the Web at http://www.ustreas.gov/press/releases/docs/regtext.pdf