The Final Split-Dollar RegulationsWhat To Do?

A second choice is to elect loan treatment for premiums paid after 2003. In this case, all premiums paid by the employer from plan inception must be treated as loans. And, the IRS will not pursue any equity in the policy at time of the election. Since the employee owns the policy, equity accruing after that date would be owned by the employee and so not be subject to income tax.

Comment: With interest rates so low, loan treatment may be advantageous. For example, if total paid-in premiums are $100,000 and if the applicable federal rate is 4%, the employee will include $4,000 in income for that year. The highest federal tax rate on that income is 35% for 2004, so the tax due would be about $1,400. For older clients, this amount could be much less than the applicable one-year term rates.

The third choice is to do nothing. In that case, the old rules should continue to apply.

Comment: We do not expect the IRS to pursue equity build-up on these policies unless the equity is accessed. The employee can continue to report income tax on the value of the economic benefit.

After 2003, what rate to use for that value is not clear. Some commentators feel the insurers one-year alternative term rate can continue to be used. I believe, though, that based upon the comments it is soliciting, the IRS is moving toward a solution where all taxpayers determine the economic value based upon the same rates–so the tax treatment will be the same regardless of the carrier.

Hopefully, the IRS will not pursue pre-Jan. 28 policies in this regard. But, even if the Table 2001 rates are required, the result will be favorable to many taxpayers.

We have discussed the agents role and the attorneys role. But what is the clients role? It is to answer questions such as: "Is the purpose of the insurance still valid? Have your needs changed? If so, what are your needs now?"

Usually the purpose of the policy is for estate liquidity or retirement planning. If estate liquidity is the purpose, the policy would be kept in force until death. In that case, the client may choose not to do anything, as discussed above.

If retirement planning is the purpose, the intention is to access the equity. In that case, the client may want to elect a transitional rule, or end the split-dollar arrangement. For example, the plan could be converted to an executive bonus plan once the employers interest is paid off. Or, the client can continue under the "old" rules but with the expectation that equity will be taxed when accessed.

Another consideration is what to do if there is no written split-dollar agreement. Cases exist where the policy was put in force, but the split-dollar arrangement was never documented. It appears that many of these instances are unintentional.

In these cases, I advise the client to ask his or her accountant how the premiums were accounted for. That usually starts a discussion that can lead to many conclusions.

It may be that what the accountant thought was happening was not, in fact, happening. For example, sometimes premiums have been deducted and sometimes premiums have not been deducted but no PS-58 costs were charged to the employee. Whatever the case, my view is that these are issues the client and accountant must address. In general, unless the difference in income taxes is significant, the accountant may not want to file amended returns.

Finally, concern exists that litigation may ensue from these regulations. If the IRS loses that litigation, as some observers suggest, a client who elected a transitional rule or otherwise ended a split-dollar arrangement may have unnecessarily lost a favorable tax situation. This is impossible to predict, but it definitely is something the client should discuss with the attorney when considering whether to end a pre-Jan. 28 arrangement.

I wish there were a simple answer for how to handle all such cases. But, as shown above, the answer depends on the facts of each situation and on unpredictable events. Therefore, it is critical that each case be evaluated individually, based on input from client, advisor and attorney.

Douglas I. Friedman, a partner in the Friedman & Downey, P.C. law firm of Birmingham, Ala., is national counsel on estate and business planning for insurers. His e-mail is [email protected].

Reproduced from National Underwriter Life & Health/Financial Services Edition, October 17, 2003. Copyright 2003 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.