Do A Year-End Check-Up On Split Dollar Planning

–The employer is treated as having a beneficial ownership in the policy.

–The economic benefit charge reduced by any premium payments made by the employee will be taxable to the employee.

–If dividends or similar benefits are received directly or in the form of additional policy benefits, it will also be taxable to the employee.

–The employee will be taxed for any substantially vested interest acquired in the policys cash value reduced by any contribution paid by the employee for that interest in the policy.

Under the Notice a Section 83 transfer doesnt occur simply because interest and other earnings from the policy cash value are in excess of the amounts due to the employer under the agreement. A taxable event would occur at the point the employee accesses or has the ability to have full control over the policy value.

On a positive note, in the event interest or other earnings are considered subject to Section 83 under subsequent IRS guidance and taxed each year as the value grows, taxation will only occur going forward and will not be retroactive.

Existing Equity Split Dollar Plans. The first thing to do, if you havent already, is notify your client of the interim guidance. The first step in evaluating the plan is to determine whether it should be treated as an employer loan under Section 7872 or as a split dollar. Most existing plans will fall under the split dollar rules.

A second step is to determine whether there is any employee equity. Although equity does not appear to be taxable while the split dollar agreement is in force, it may be taxable income at rollout/termination of the agreement during the insureds lifetime. Hopefully, final IRS guidance will clarify. If the current design is no longer effective for the client, tax can be paid and the plan design can be switched to a bonus arrangement.

Reverse Split Dollar Plans. Notice 2001-10 confirms the IRS is concerned that the employer's "rent" payments for the death benefit are overstated using P.S. 58 rates. In essence, the employee is benefiting from the employers payment without being taxed. By eliminating the P.S. 58 rates, the leverage created in a reverse split dollar plan is minimized.

Going forward, the employer can terminate the reverse split dollar agreement and simply bonus the premium to the owner/employee. Another option is to continue the plan with the employer paying a smaller portion based on Interim Table 2001 and the remainder of the premium as a bonus to the employee.

Private Split Dollar Plans. Private split dollar was not specifically addressed in the Notice. In a private split dollar arrangement, the insured spouse typically gifts the economic benefit to an irrevocable trust. Based on the Notice, the gift would now be based on Interim Table 2001 or insurer one year term rates.

In most situations, insurer one-year term rates are used. If the plan design follows existing private letter rulings on private split dollar, the spouse advancing premium is entitled to receive all cash value, not just premiums advanced. In this situation, the equity split dollar guidance does not apply.

If the private split dollar plan uses an equity split dollar approach, a logical extension of the Notice would result in the equity portion being treated as a gift at rollout.

Other Planning Techniques. With all the plan design flexibility available with nonqualified plans, there are many creative ways to design a plan to meet your clients needs. Here are a couple of ideas.

Split Dollar Alternative.This approach avoids both the equity split dollar and economic benefit issues raised in the Notice. This concept can be packaged as a means for employers to provide a bonus and use a second key person policy to recover costs.

Split Dollar/Selective Executive Retirement Plan (SERP) Combination. This technique delays taxation until retirement and also provides a pre-retirement income tax-free death benefit for the employees beneficiary. It is set up as either an endorsement or collateral assignment split dollar.

Notice 2001-10 creates various challenges and uncertainties. By following the steps found in figure 2, you can meet the clients need and solidify a long-term relationship.

, JD, CLU, is director of advanced markets, Principal Life Insurance Company, Des Moines, Iowa, specializing in executive benefit planning, business succession, and estate planning. He may be reached via e-mail at [email protected].

Reproduced from National Underwriter Life & Health/Financial Services Edition, October 15, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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