Time To Act On Split-Dollar Safe Harbor Provisions
The good news is that the Internal Revenue Service has issued rules finalizing the previously proposed split-dollar regulations (Treasury Decision 9092 & Revenue Ruling 2003-105 ).
The final regulations provide comprehensive tax rules governing split-dollar arrangements entered into after Sept. 17, 2003, or arrangements entered into on or before Sept. 17 that are “materially modified.”
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Therefore, any existing arrangements that are not modified will continue to be subject to the rules in Notice 2002-8 and other prior tax law guidance.
The bad news? The IRS declined requests from the industry to extend the Dec. 31, 2003, “safe harbor” deadline for pre-Jan. 28, 2002, equity established in Notice 2002-8.
That means financial professionals have got to get cracking, setting appointments and reviewing existing equity split-dollar arrangements with clients and their advisors.
The provisions contained in Notice 2002-8 provide considerable grandfather protection through a few “safe harbor” rules that may help avoid taxation of participant equity. Brokers should review the practical steps that must be taken to comply with the Notice before Dec. 31, 2003.
Safe Harbor #1: Maintain Arrangement Until Death. The first safe harbor rule pertains to those split-dollar arrangements entered into before the date of final regulations (Sept. 17, 2003).
It provides that as long as the value of current life insurance protection is treated as an economic benefit, the IRS will not treat the arrangement as having been terminated and will not impose income or gift tax consequences on the non-owner employees or donees share of cash values. Consequently, it appears that simply by continuing to pay the economic benefit amount until death, the tax on policy equity is avoided.
However, this also means that if the arrangement is terminated and current life insurance protection is no longer provided, the income or gift tax consequences will be imposed on the non-owners share of cash values.
Fortunately, Notice 2002-8 contains two other safe harbor rules that, as explained below, allow the parties to certain split-dollar arrangements to avoid incurring income or gift tax consequences on equity cash values.
Safe Harbor #2: Terminate Arrangement. The second safe harbor provides that for economic benefit equity split-dollar arrangements entered into before Jan. 28, 2002, under which a sponsor has made premium payments and is entitled to full repayment, the IRS will not assert that there has been a taxable transfer of equity cash values to an employee or donee if the arrangement is terminated before Jan. 1, 2004.
This important safe harbor means that pre-Jan. 28, 2002, equity split-dollar arrangements may be terminated before Jan. 1, 2004, without the employees or donees share of cash value being subject to income or gift tax.
There are no instructions in IRS Notice 2002-8 on how a pre-Jan. 28, 2002, equity split-dollar arrangement is to be terminated to achieve the desired tax results. The rights of the parties under such circumstances should, however, be dictated by the terms of the split-dollar agreement and the agreement should be examined to determine these items:
Timing requirements for the notice of termination;
Address where the notice of termination is to be sent;
Provisions for repayment of the sponsor;
Rights of the employee/donee to the policy after the employer/donor is repaid the premium advances; and,