Bill Restricts Some NQ Deferred Comp

Laurie Lewis, chief counsel for federal taxation with ACLI, says in testimony before the IRS that the proposed regulations look to whether there is current access to the cash surrender value of the underlying life insurance contract in determining whether the non-owner, or employee, in an endorsement arrangement will be subject to tax on increases in cash value.

“Unfortunately,” she says, “the definition of current access is both overly broad and lacks sufficient clarity. Individuals entering into split-dollar arrangements need fairness and clarity–the current guidance does not adequately provide either.”

The proposed regulations, Lewis notes, state that the non-owner has “current access” if the policy cash value is “directly or indirectly assessible by the non-owner, inaccessible to the owner or inaccessible to the owners general creditors.

The regulations state that the non-owner has “current access” under a variety of situations, she notes, but one particularly troubling situation says there is current access if, by operation of law or any contractual undertaking, the owners creditors cannot, for any reason, effectively reach the full cash value in the event of the owners insolvency.

She cites an example in which the non-owner is treated as having “current access” because a state law provides that cash value is inaccessible to the creditors of the owner.

In this situation, Lewis notes, the non-owner does not have any direct or indirect right to have access to any portion of the cash value, there is no contractual restriction on the rights of general creditors of the owner, and the non-owner has no greater rights than the general creditor and derives no current benefit from the state law restriction.

Nonetheless, Lewis says, because of the state law that limits the reach of the owners creditors, the non-owner is treated as having current access to the cash value and is accordingly taxed.

In addition to unfairly and prematurely taxing these non-owners, she says, the new rule could potentially tax non-equity split-dollar arrangements, those in which the employee never receives any interest other than current life insurance protection, merely because of state creditor laws that provide nothing of value to the non-owner.

“These employees who will never receive any of the cash value could be taxed on the cash value increases if the employers creditors were restricted in any way by state law from reaching the policy cash value,” Lewis says. “This cant be right.”

David Downey, who chairs AALUs Split Dollar Tax Force, says the most important part of AALUs presentation to the IRS is a request to extend the safe harbor from Dec. 31, 2003, to Dec. 31, 2004.

Downey says that since the final rules are still unknown, AALU members dont know how to counsel their clients.

In addition, he says, AALU does not agree with the IRS definition of constructive receipt under the proposed rules. Life insurance, he says, has always been taxed under Sections 72 and 101 of the Tax Code.

AALU does not believe this can be changed by regulation, he says.

Reproduced from National Underwriter Life & Health/Financial Services Edition, August 4, 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.