The Dangers And Opportunities Of The New Split-Dollar Regulations
The Chinese have a symbol, pronounced jitsui, which means both danger and opportunity.
Jitsui is a perfect descriptor for the new market for split-dollar life insurance plans. Final regulations issued by the Internal Revenue Service and U.S. Treasury aimed at curbing the abuses created by some split-dollar life insurance plans were published in the Federal Register on Sept. 17, 2003.
Since then, substantial commentary has been published about “rescuing” pre-Sept. 17 split-dollar plans, if indeed they needed to be rescued. Much of the commentary also has detailed the potential pitfalls for split-dollar plans going forward.
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The good news is that the marketing opportunities for split-dollar plans are substantial, despite the new regulations. Tax law changes often provide new creative planning opportunities.
Split dollar may still be one of the most effective solutions to minimize individual income and gift tax consequences for dynasty trust-owned life insurance. It is still one of the better ways to preclude a double tax on corporate accumulated earnings when those earnings are used to fund a split-dollar welfare benefit. Split dollar also can be used to fund a salary continuation benefit for select employees and it can provide the means to execute a group term carve-out strategy. It is an effective way to use the corporate pocketbook to fund a cross-purchase buyout obligation between business owners. The applications are limited only by ones creativity.
Endorsement Split-Dollar Applications:
SERPAn endorsement split-dollar (ESD) plan can informally fund a supplemental employee retirement plan (SERP) while simultaneously providing for an income-tax-free spousal benefit should the employee die before retirement. This application can avoid the double income in respect of a decedent (IRD) tax applicable to standard deferred compensation plans.
Since endorsement split-dollar constitutes an employer-owned asset, it continues, as always, to be subject to taxation as an economic benefit. Double-tax benefits are available to the corporation in the form of tax-free withdrawals up to cost basis for non-modified endowment contracts or policy loans followed by tax deductible distributions to the insured at retirement.
Deferred CompensationAnother application for ESD is to simulate a deferred compensation asset transfer plan. The ESD agreement can link a future transfer of policy ownership from the corporation to the key person after a specific number of years of service, or when certain performance requirements have been met. Employee tax consequences upon the transfer of the life insurance policy to the insured can be minimized or neutralized with a bonus at rollout time. A new employees cost basis in the life insurance is generated by the taxes incurred, which can permit greater tax-free income withdrawals followed by tax-free loans to supplement retirement income needs.
Stock Redemption Purchase ESD can fund a discounted stock redemption purchase plan to transfer a business to an unrelated business owner. When the insured dies, the deceased owners spouse receives a tax-free fringe benefit. Simultaneously the corporation can use its interest in the policy cash values to initiate an installment purchase stock buyout from the deceased owners estate. ESD employer premium payments may effectively reduce the corporate accumulated earnings threshold to $250,000 to avoid an additional 15% tax on excess earnings.