The New Split-Dollar Loan Regime: Who Will Do This?
Now that final split-dollar regulations have been published and the industry has had a chance to digest the new rules, we can now assess whether any of our clients should use this planning.
Its the new loan regime that seems to be the hardest to get our arms around. Already, some attorneys and accountants have declared the maintenance of split-dollar loans to be more trouble than theyre worth. We need now to sort through the rules and the numerical projections and determine which of our clients should be considering these loans and how they might best structure them, maintain them and eventually pay them off.
First, an entire class of prospects can be eliminated from consideration. Public corporations will not be implementing loan regime split-dollar plans due to the prohibition on extensions of credit to corporate shareholders and officers as prescribed in the Sarbanes-Oxley Act.
A similar situation may be found when dealing with officers and directors of certain nonprofit organizations. Many such organizations restrict compensation-related loans in their bylaws or charters. The existence of these restrictions should be determined before recommending loan regime split dollar.
In regard to public corporations, many tax advisors are assuming Sarbanes-Oxley would also extend to economic benefit regime plans. While its hard to imagine that these plans could violate the intent or spirit of the act, the fact that the act carries criminal penalties seems to have caused this conservative stance.
The remaining prospects for loan regime split dollar would seem most often to fall into the category of closely held business owners. While there are certainly corporate buy-outs and other business insurance applications for split dollar, it is often the personal estate planning and wealth transfer needs of these clients that create their desire to use the corporate checkbook to finance their life insurance.
In addition, loan regime plans under the new regulations maintain the leverage achieved when the corporation pays for a third-party-owned policy. The premium advances from the corporation are deemed to be loans to the insured and then a secondary loan to the third-party owner. The insureds gifts to a third-party owner may be limited to amounts needed to pay interest on the loans. By limiting the gifting, the insured may save annual gift tax exclusions and/or the unified credit.
Due to the uncertainties of estate tax repeal, there has been greater interest on the part of taxpayers to build flexibility into their estate liquidity planning. Private split-dollar arrangements should continue to be popular tools to provide funding for trust owned insurance while maintaining a means to access the policy values. These arrangements typically call for the use of a defective grantor trust so that interest payments by the trust will not be taxable income to the grantor. If interest is foregone, it will be considered a gift from the donor to the trust and then a retransfer of that amount to the donor.
Similarly, if loan principal is later forgiven, a gift is deemed to be made by the donor to the trust. For this reason, loan forgiveness may best be done over a period of years once premium gifts have ended. This method of loan crawl-out will also be useful in employer sponsored plans when there is no desire to pay back the premium loans.