Be Mindful Of The Sarbanes-Oxley Acts Effect On Split-Dollar Plans
If you have sold a split-dollar plan to an employee at a public company, take heed: paying the next premium may be a criminal offense punishable by substantial prison terms. Congress recently enacted the Sarbanes-Oxley Act, a securities law intended to rein in corporate abuse.
The Act prohibits personal loans to "any director or executive officer (or equivalent thereof)" of public companies. Privately held employers are not affected. The Act does not define "executive" or "personal loan."
When a company pays a premium on a split-dollar plan, the company is making its money available to provide a life insurance benefit to the insured. Some of these transactions are established as loans, with the employee paying interest annually. Clearly, these loan transactions would be subject to the new law.
But, the more common arrangements, particularly those in existence before IRS Notice 2002-8, do not provide for loans with annual interest. When those arrangements end, the employer receives its premiums back, either through cash surrender values or death benefits. Sometimes the employer does not receive any interest on its reimbursement.
Either way, the employer premiums provide the employee with life insurance protection. IRS Revenue Ruling 64-328 recognizes that by paying the policy premium, the employer is conferring a benefit on the employee. The value of the benefit is the value of the term insurance provided to the employee. In addition, the employer usually has no recourse against the employee if the cash values are not sufficient to reimburse the employer or to provide a return on the employers premium payments.
The question, then, is whether use of company money in this way is a personal loan. Some industry observers believe that split-dollar may not have been an intended target of the Act because the IRS only just recently issued Notice 2002-8 this past January. The Notice was then followed by lengthy proposed regulations. The Notice and the proposed regulations define whether a split-dollar arrangement should be treated as a loan–at least, for tax purposes.
Unfortunately, we believe that securities regulators will reach their own conclusions and will not be influenced by tax law definitions. In fact, we believe that the aim of Sarbanes-Oxley is entirely different than the IRS rules. Under that Act, Congress was not concerned with the taxation of these arrangements. Rather, Congress was concerned with prohibiting arrangements whereby executives were profiting at the public trough. Since large split-dollar plans apparently were part of the Enron executive compensation, split-dollar may well have become an intended target.
The Act does not apply to an existing loan, provided that there is not a material modification to any term of the loan or any renewal of the loan after the date of enactment. We believe that the payment of additional premiums, which increases the employers participation in the split-dollar arrangement, would probably be considered as a material modification, or renewal, of a loan if split-dollar was considered as a personal loan.
Whether Congress intended to include split-dollar plans creates a difficult situation for public companies as they scramble to react to the new law. For public clients with these plans, securities counsel should be consulted immediately and no further premiums should probably be paid before doing so. Remember, we are talking about jail terms for violations, not just penalties and interest charged by the IRS.
