IRS Releases Proposed Split-Dollar Rules

By Steven Brostoff

Washington

The Internal Revenue Service has issued proposed rules on equity split-dollar arrangements that have some practitioners questioning the viability of the product.

Three sources, all of whom asked not to be identified, told National Underwriter that the IRS appears to have anticipated every possible use of split-dollar that could be considered “abusive” and shut it down.

One source said he expects the industry to work hard to try and alter the regulations. He noted that the IRS has set a deadline of Oct. 7, 2002 for written comments and has scheduled a public hearing for Oct. 23.

In all likelihood, he said, the IRS will not issue a final rule until next year.

At that time, this source said, the industry will have to examine the final rule and possibly make a decision on whether to challenge the IRS in court.

Laurie Lewis, chief counsel with the American Council of Life Insurers, Washington, says, however, that the proposed regulations still require a lot of study.

While some media reports, she says, have raised questions about the viability of equity split-dollar, nothing in the proposal says that life insurers cannot use split-dollar.

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

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

In the proposed rules, the IRS says that as indicated in Notice 2002-8, split-dollar life insurance arrangements will be subject to two mutually exclusive tax regimes.

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

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

The tax consequences of that transfer, the IRS says, will depend on the relationship between the two parties.

Thus, the IRS says, the transfer may constitute a payment of compensation, a distribution under Section 301 of the tax code, a gift or a transfer having a different tax character.

Alternatively, under the loan regime, the non-owner is treated as loaning premium payments to the owner.

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

If the loan does not provide for sufficient interest, it will be considered a below market loan subject to the relevant sections of the tax code.

If the loan provides for sufficient interest, it is subject to the general rules for debt instruments.

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

David Winston, vice president of government affairs with the National Association of Insurance and Financial Advisors, Falls Church, Va., says that in a departure from Notice 2002-8, these new regimes apply to donor/donee as well as shareholder arrangements.

In addition, he says, there are some early concerns in the way the proposed rules would characterize basis and attribute income for tax purposes.

However, Winston emphasizes, this is only an initial analysis and further examination of the proposal is ongoing.


Reproduced from National Underwriter Life & Health/Financial Services Edition, July 15, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.