An Overview Of The 2003 Proposed Regulations

The focus of these additional proposed regulations is the methodology related to the calculation of equity split dollar under what the IRS calls the “Economic Benefit Regime.”

Although there are numerous issues that have never been addressed by the IRS involving economic benefit calculations outside of equity arrangements, the IRS was emphatic in the preamble to these 2003 proposed regulations that they only affect equity split dollar under the economic benefit approach. They stated that other issues would be addressed in the final regulations, based on comments received on the 2002 proposed regulations.

In these 2003 proposed regulations, the IRS taxes the equity (cash value) build-up associated with split dollar as constructive income under Tax Code Section 61. Section 61 is a broad Tax Code provision covering many types of income, including income that is considered constructively received (i.e., funds, or assets, where a client maintains certain rights or control, such as life insurance values, even if they do not actually take physical receipt of the funds).

In many ways this new methodology puts taxpayers in a position stricter than might have been imposed under TAM 9604001, the first IRS pronouncement on equity split dollar. Under that TAM, the taxpayers involved were told to recognize income each year on the life insurance equity build-up; however, they were given discretion as to the method they could elect to utilize. In IRS Notice 2002-8, taxpayers were allowed to unwind their pre-Jan. 28, 2002, equity split-dollar arrangements prior to Dec. 31, 2003, and avoid taxation on the equity. Those who did not terminate their arrangements by that date faced taxation but only when cash was received from the life insurance policy or upon termination. Under these 2003 proposed regulations, the cash value increase is taxed to the insured every year.

By taking an approach using this Tax Code section, the IRS appears to be trying to close the door on other tax theories related to equity split dollar that evolved in response to TAM 9604001. Under the Section 61 approach, a client does not own the policy. Therefore, clients now cannot claim that part of each years cash value increase is not taxable to them because they built a tax basis in the life insurance policy by paying tax in earlier years. Additionally, clients cannot take losses on their life insurance policies in years when cash values drop. This is discussed in detail in the preamble to the 2003 proposed regulations.

Mark Teitelbaum


Reproduced from National Underwriter Edition, June 23, 2003. Copyright 2003 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.