The Final Split-Dollar Regulations– What To Do?
In the next few months, how should agents analyze split-dollar arrangements that existed before Jan. 28, 2002?
Those are the plans that may elect transitional rules under the new split-dollar regulations. (See Treasury Decision 9092 for the complete regulations.) Decisions concerning the plans are complex, so many advisors are searching for effective strategies.
The final regulations are effective only for split-dollar arrangements established after Sept. 17, 2003. If a split-dollar arrangement is materially modified after that date, the new rules will apply to it.
Since most questions agents have about this involve what were formerly called “collateral assignment plans,” this article will focus only on those plans. (We will not address employer-owned endorsement type plans. Also, we assume that readers know the provisions of the new regulations regarding the tax treatment of employee-owned loan type arrangements.)
In a collateral assignment plan, now called “employee-owned,” the employee owns the life policy, the employer pays most if not all of the premium; the policy is collaterally assigned to the employer to secure repayment of the employers premiums; and the employee pays income tax on the value of the economic benefit (what used to be called the PS-58 cost or alternative one-year term cost).
In deciding what to do, the agent, client and attorney have different roles to play.
The agent needs to provide the attorney with an in-force ledger. As the attorney, I expect the agent to be able to show important numbers in this ledger, such as total premiums paid, current cash values, whether there is policy equity (i.e., whether the cash values exceed the amount collaterally assigned to the employer), and growth projections for the policy.
The agent also should be prepared to discuss:
–Whether the agent believes the growth projections are reasonable. While no one can predict the future, explaining how the insurer is determining interest credits lends credibility to the agent, and is another piece to the puzzle.
–Whether the policy itself is still suitable for the clients needs, or whether another policy may be more appropriate. If the policy needs to be changed, we believe that a Section 1035 exchange would constitute a material modification that would subject the split-dollar arrangement to the new final regulations.
The attorneys role is to determine the type of agreement (Employer-owned “endorsement” or Employee-owned “collateral assignment”) and what the employers interest is under that agreement. The attorney should also determine whether a transitional rule is available and how to elect it.
For pre-Jan. 28, 2002, policies, there are three choices:
One choice is to end the split-dollar arrangement before Jan. 1, 2004. In that case, the Internal Revenue Service will not pursue equity in the policy. This choice is most likely to be made if the policy has equity in it, depending on the clients needs, as discussed below.
Comment: Ending the split-dollar arrangement is different than ending the policy. To end the split-dollar arrangement, the employee must pay off the employers interest. If the policy is then surrendered, the usual rules of taxation would apply to any amount received above the employees basis in the policy. So, this transition rule applies to the split-dollar arrangement, as distinct from the policy itself.