Its Time To Sell The New Loan Regime Split Dollar
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As of press time, the life insurance industry awaits final split-dollar regulations from the Treasury Department. This, however, is not a reason to hold off on helping your clients.
Its time to embrace what the split-dollar proposed regulations have already offered, and help businesses and their employees effectively pay for life insurance using split dollar. It is time to offer exactly what the Internal Revenue Service is proposing–split dollar as a "loan regime."
Whether you call this concept "Split Dollar" or simply a business loan, in this low interest rate environment it can be an attractive benefit for key employees and owners in non-public companies (public companies are not likely to make loans to key employees as a result of the Sarbanes-Oxley Act).
Forty years ago, the IRS struggled with the issue of companies helping employees pay for personal life insurance using zero interest loans. The governments concern was that even though the employee derived an economic benefit in the form of the loan, there was no way to tax the transaction. At the time, no mechanism existed for taxing low- or no-interest loans to employees.
The need to tax this transaction led to the Revenue Ruling 64-328, which defined the economic benefit as being the mortality element of the insurance benefit. Since the employee could die during the year, an economic benefit existed, and the IRS would impute the one-year mortality cost as the taxable benefit. This is the genesis of the split-dollar concept.
The overall issue of companies providing low- or no-interest loans to employees was addressed by legislation in 1986. IRC Section 7872 established that "below market loans" to employees would result in imputed income equal to a federally reported minimum loan rate. With this provision, the IRS has a means of taxing transactions involving the lending of money between employer and employee.
So now, as the Treasury and the industry struggle with a new definition and set of rules regarding split dollar, the government has a way to tax the loan element of a split-dollar arrangement. The concept of collateral assignment split dollar being viewed as a loan is embodied in the proposed regulations issued in July 2002. Since IRC 7872 is statutory law, the IRS generally wants to use the "loan regime" in collateral assignment cases in lieu of the "economic benefit" approach, the approach used for the last 40 years.
Re-characterizing split dollar as a loan can be a viable approach to situations where the employer seeks to help the employee pay for the cost of permanent life insurance. In the right situation, the loan regime is superior to the economic benefit regime in terms of tax and financial efficiency. The three primary efficiencies are:
1. Paying tax on a low imputed loan rate is better than the employee having to acquire personal funding at a higher interest rate;
2. The employee no longer has to report an "economic benefit" for the mortality aspect of the life insurance; and,
3. At rollout, the employee isnt taxed on the equity in the policy (the difference between the cash value and the premiums paid).
