116 / How are split-dollar life insurance arrangements treated for gift tax purposes?

Gifts may arise in a split-dollar arrangement when a donor provides a benefit to a donee. For example, an employee or shareholder who irrevocably assigns his or her interest in a compensatory or shareholder split-dollar arrangement ( Q 4017) to a third party (such as a family member) may make gifts to such third party (including annual gifts of the amount the employee or shareholder is required to include in income). Also, a donor may make gifts to an irrevocable life insurance trust under a private split-dollar arrangement.

The treatment of split-dollar arrangements may differ depending on whether the arrangement was entered into or modified after September 17, 2003.

Post-September 17, 2003, Arrangements

Regulations generally provide that the treatment of a split-dollar arrangement depends on whether the donor is the owner of the life insurance contract.¹ Even if the donee is named as the policy owner, the donor may be treated as the owner if the only economic benefit provided to the donee is the value of current life insurance protection.

If a life insurance trust is the owner of the policy, the donor makes premium payments, and the donor is entitled to recover an amount equal to the premiums, the donor is treated as making a loan to the trust in the amount of the premium payment. If the loan is repayable on the death of the donor, the term of the loan is equal to the donor’s life expectancy on the date of the payment (under Treasury Regulation Section 1.72-9). The value of the gift equals the premium payment less the present value (determined under IRC Section 7282) of the donor’s right to receive repayment. If there is no right to repayment, the value of the gift equals the premium payment.

If the donor is treated as the owner of the policy, the donor is treated as making a gift to the trust. The value of the gift equals the economic benefits provided to the trust, less the amount of premium paid by the trustee. If the donor’s estate is entitled to receive the greater of (1) the aggregate premiums paid by the donor or (2) the cash surrender value, the gift is equal to the cost of life insurance protection less premiums paid by the trustee. If the donor’s estate is entitled to receive the lesser of (1) the aggregate premiums paid by the donor or (2) the cash surrender value, the gift is equal to the cost of life insurance protection, plus the amount of cash surrender value to which the trust has current access (except to the extent taken into account in an earlier year) and any other economic benefit provided to the trust (except to the extent taken into account in an earlier year), less premiums paid by the trustee. If the donor is treated as the owner of the policy, amounts received by the life insurance trust under the contract
(e.g., dividends or policy loan) are treated as gifts from the donor to the trust.

No matter who is treated as the owner of the life insurance policy, there may be a gift upon transfer of an interest in a policy to a third party. See Revenue Ruling 81-198, below.

Pre-September 18, 2003, Arrangements

In a 1978 ruling, a wife owned a policy on the split-dollar plan on the life of her husband. The husband’s employer paid the portion of the premiums equal to annual cash value increases and was entitled to reimbursement from death proceeds. The IRS ruled that the value of the life insurance protection provided by the employer, which the IRS also ruled was included in the husband’s income ( Q 4017), was deemed to be a gift from the husband to the wife, subject to the gift tax.²

In Revenue Ruling 81-198,³ an employee made a gift of his rights under a basic plan of split-dollar insurance (as described in Q 4017) in which the insurance was premium paying and was in force for some time. The IRS ruled that three elements are valued. First, the value of the insured’s rights in the policy at the date of the gift is the interpolated terminal reserve plus the proportionate part of the last premium paid before the date of the gift covering the period beyond that date, reduced by the total of premiums paid by the employer. Second, the premiums paid by the insured following the date of the gift are gifts on the date paid. Third, the value of the life insurance protection provided by the employer, included in the employee’s gross income, is deemed to be a gift by the employee.

In a letter ruling dated December 4, 1972, the IRS found that a gift of the amount at risk under a split-dollar plan is valued as the greater of (1) the value of the insurance protection as computed for income tax purposes ( Q 4018) or (2) the difference between the premium payment and the increase in the cash surrender value of the policy. A later technical advice memorandum stated that, with respect to a split-dollar plan, a gift may be made of (1) the value of the insurance protection and (2) increases in cash surrender values in excess of premiums paid by, and returnable to, the corporation.⁴