Be Mindful Of The Sarbanes-Oxley Acts Effect On Split-Dollar Plans

If you have sold a split-dollar plan to an employee at a public company, take heed: paying the next premium may be a criminal offense punishable by substantial prison terms. Congress recently enacted the Sarbanes-Oxley Act, a securities law intended to rein in corporate abuse.

The Act prohibits personal loans to “any director or executive officer (or equivalent thereof)” of public companies. Privately held employers are not affected. The Act does not define “executive” or “personal loan.”

When a company pays a premium on a split-dollar plan, the company is making its money available to provide a life insurance benefit to the insured. Some of these transactions are established as loans, with the employee paying interest annually. Clearly, these loan transactions would be subject to the new law.

But, the more common arrangements, particularly those in existence before IRS Notice 2002-8, do not provide for loans with annual interest. When those arrangements end, the employer receives its premiums back, either through cash surrender values or death benefits. Sometimes the employer does not receive any interest on its reimbursement.

Either way, the employer premiums provide the employee with life insurance protection. IRS Revenue Ruling 64-328 recognizes that by paying the policy premium, the employer is conferring a benefit on the employee. The value of the benefit is the value of the term insurance provided to the employee. In addition, the employer usually has no recourse against the employee if the cash values are not sufficient to reimburse the employer or to provide a return on the employers premium payments.

The question, then, is whether use of company money in this way is a personal loan. Some industry observers believe that split-dollar may not have been an intended target of the Act because the IRS only just recently issued Notice 2002-8 this past January. The Notice was then followed by lengthy proposed regulations. The Notice and the proposed regulations define whether a split-dollar arrangement should be treated as a loan–at least, for tax purposes.

Unfortunately, we believe that securities regulators will reach their own conclusions and will not be influenced by tax law definitions. In fact, we believe that the aim of Sarbanes-Oxley is entirely different than the IRS rules. Under that Act, Congress was not concerned with the taxation of these arrangements. Rather, Congress was concerned with prohibiting arrangements whereby executives were profiting at the public trough. Since large split-dollar plans apparently were part of the Enron executive compensation, split-dollar may well have become an intended target.

The Act does not apply to an existing loan, provided that there is not a material modification to any term of the loan or any renewal of the loan after the date of enactment. We believe that the payment of additional premiums, which increases the employers participation in the split-dollar arrangement, would probably be considered as a material modification, or renewal, of a loan if split-dollar was considered as a personal loan.

Whether Congress intended to include split-dollar plans creates a difficult situation for public companies as they scramble to react to the new law. For public clients with these plans, securities counsel should be consulted immediately and no further premiums should probably be paid before doing so. Remember, we are talking about jail terms for violations, not just penalties and interest charged by the IRS.

If split-dollar is to be included as a personal loan, we dont believe that there is a silver bullet for existing plans. One solution might be to end the plan immediately. That would certainly remove the problem, but may not make sense financially. A consideration in this regard would be what treatment may be elected under Notice 2002-8, which sets forth the current IRS approach until final regulations are published. For example, some provisions of the Notice permit a tax-free termination of the split-dollar arrangement. If such a provision is available, this may be an easier choice to make.

Another possibility is to skip a premium payment. This may be possible under the policy provided that there is enough cash value to sustain it, either as universal life insurance or through automatic premium loans on traditional whole life insurance.

Perhaps a formal premium loan would be appropriate to pay the premium. Again, while the securities laws must be consulted, it would appear that taking a premium loan would not be a material modification of a loan or an additional extension of credit.

Another approach may be to treat any further premium payments as compensation to the employee. This would cause accounting complexities under the split-dollar arrangement, as it would become necessary to track the employers portion of the cash values and the employees portion. Applying a ratio approach may be sufficient in this regard.

What if a premium has already been paid, inadvertently, such as through a bank draft? One possibility may be to reverse the transaction, particularly if payroll taxes are not yet due. While this may not reverse that a loan existed, it may be the best choice in this situation. If not, then the alternatives mentioned above should be considered.

We have been told, anecdotally, that split-dollar was not intended to be affected by this legislation. But, on the other hand, recently Senator Charles Schumer, D-N.Y., was quoted as saying that the Act was drafted broadly on purpose, not knowing what exactly might fall within it, to eradicate perceived corporate abuses.

The life insurance industry is seeking clarification of the extent of the Act. Considering Sen. Schumers statements and the negative political atmosphere for anything favorable to executives of public companies, we believe that if clarification is given, it will probably not be favorable for split-dollar.

Douglas I. Friedman and Heather C. Downey are partners in the Friedman, Pennington & Downey, P.C. law firm of Birmingham, Ala., Friedman, who serves as national counsel on estate and business planning for insurers, can be e-mailed at. doug@fpdlaw.com. Downeys e-mail is heather@fpdlaw.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, September 30, 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.