The Treasury Department should extend the effective date of its proposed regulations on split-dollar life insurance arrangements to Jan. 1, 2005, life insurance agents say.
Unless the effective date is extended, agents say, taxpayers will have little, if any, time to utilize certain transition and safe harbor rules in the proposed regulations.
These comments were submitted jointly to Treasury by the Association for Advanced Life Underwriting and the National Association of Insurance and Financial Advisors.
The issue involves two sets of proposed rules regarding split-dollar arrangements. The first set, issued in 2002, mandates that income and gift tax consequences of a split-dollar arrangement follow the formal ownership of the policy, AALU and NAIFA, both of Falls Church, Va., note.
Thus, they say, payments made by the “owner” of the policy for the benefit of a nonowner will be taxed using an economic benefit analysis, while payments made by a “nonowner” for the benefit of the owner will be treated as loans.
The second set, issued in 2003, states that the value of the economic benefits provided to the nonowner under the economic benefits analysis equals the cost of current life insurance protection, the policy cash value to which the nonowner has “current access” and the value of any other economic benefits, AALU and NAIFA note.
But given the realities of time pressures on an overextended Treasury staff, they say, it is doubtful that the regulations will be finalized before fall of 2003.
Since the regulations set Jan. 1, 2004, as the date of termination of the transition and safe harbor rules, taxpayers will have little time to utilize them, AALU and NAIFA say.
“This lack of adequate time is particularly disturbing because, whatever rules are promulgated in the final regulations, taxpayers should be provided with reasonable time in which to coordinate those rules with decisions respecting safe harbor implementation,” the groups say.
“Most taxpayers have, in fact, been deferring these decisions pending release of the final regulations,” AALU and NAIFA add.
The groups note that depending on the specific final rules, taxpayers will be faced with decisions on whether to employ the safe harbors with regard to existing arrangements, continue existing arrangements, terminate the arrangements entirely, make adjustments which can be determined only after the final regulations are issued, or enter into new split-dollar arrangements.
Taxpayers, the groups note, will seek the advice of attorneys and other advisors, who will have to explore dozens, if not hundreds of cases.
That is why, they say, the implementation date should be postponed one year to Jan. 1, 2005.
Substantively, AALU and NAIFA, along with the American Council of Life Insurers, Washington, question the “current access” provision noted above.
AALU and NAIFA say that the concept of “current access” to policy cash values is based on the income tax doctrine of “constructive receipt.”
Under the proposed regulations, AALU and NAIFA note, a nonowner will be deemed to have current access to any portion of the policy cash value that is directly or indirectly accessible by the nonowner, inaccessible to the owner or inaccessible to the owners general creditors.
The term “access,” they add, includes any direct or indirect right of the nonowner to obtain, use or realize potential economic value from the policy cash value.
The right to withdraw from the policy, borrow from the policy, or effect a total or partial surrender of the policy will be considered “access,” the groups say.
But applying the doctrine of “constructive receipt” to the taxation of the investment element of a life insurance contract directly contravenes the Internal Revenue Code, the groups say.
The inside buildup, or investment element of a cash value life insurance policy is not taxable until case is actually (not constructively) accessed, they say.
Thus, AALU and NAIFA say, the approach in the 2003 regulation is inconsistent with the tax code and must be viewed as an invalid attempt to tax this value.
In separate comments, ACLI agrees that applying the doctrine of constructive receipt and cash equivalence to cash value increases in life insurance policies is inappropriate.
First, ACLI says, these doctrines have never been applied to life insurance.
“It is counterintuitive that cash value increases that are not taxable to the owner of the policy become taxable to the “nonowner” under a split-dollar arrangement because he or she has the rights of the owner,” ACLI says.
Moreover, ACLI says, the tax policy concerns are aggravated when the policy is variable and losses are not recognized.
Conceivably, cash value increases could be taxed in one year, lost the next year and re-taxed the following year due to market fluctuations.
“This result is impossible to justify, particularly when it is based on an already strained construction of the law,” ACLI says.
Reproduced from National Underwriter Edition, July 14, 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.