Time To Act On Split-Dollar 'Safe Harbor' Provisions

Rights of the employer/donor to the policy or its cash or loan values if the employer/donor is not repaid the premium advances.

The termination should be preceded by the appropriate corporate resolution authorizing the action or actions to be taken.

Any debt to the employer/donor that is forgiven at termination of the split-dollar arrangement would be income or a gift to the employee/donee depending on the relationship of the parties.

Safe Harbor #3: Convert from Economic Benefit Tax Regime to Loan Regime. Notice 2002-8 provides two circumstances under which a split-dollar arrangement may be changed from the economic benefit to the loan regime to prevent equity cash values from being treated as a taxable transfer to the employee/donee on subsequent termination of the split-dollar arrangement. Those circumstances are as follows:

Arrangements entered into before Jan. 28, 2002. For economic benefit equity split-dollar arrangements entered into before Jan. 28, 2002, under which a sponsor has made premium payments and is entitled to full repayment, the parties may treat all the premium advances as loans if for all periods beginning on or after Jan. 1, 2004, all premium advances from the inception of the arrangement (less any repayments) are treated as loans entered into at the beginning of the first taxable year that the loan treatment is adopted.

Arrangements entered into before the date of final regulations (Sept. 17, 2003). For arrangements entered into before the date of final regulations the parties may treat all the premium advances as loans if all payments by the sponsor from the inception of the arrangement (less any repayments) are treated as loans at the beginning of the first taxable year in which the loan regime is adopted.

It should be noted that for arrangements entered into before Jan. 28, 2002, the loan documents should be executed prior to Jan. 1, 2004, if the desire is to avoid tax on existing equity cash value, while the second loan safe harbor does not specify a deadline for electing the loan regime. If the policy subject to the split-dollar arrangement does not contain equity on Dec. 31, 2003, it appears that the loan regime can be elected at a later date.

The Notice discusses how to convert split-dollar arrangements from an economic benefit regime to the loan regime. Notice 2002-8 states that under either of the above circumstances the parties must report the tax treatment of the arrangements after conversion to the loan regime as loans in accordance with IRC 1271-1275 and 7872. It should be noted in this regard that the original issue discount rules of IRC 1271-1275 apply to demand loans as well as term loans.

The actual steps for converting from the economic benefit regime to the loan regime would seem to start with the creation of a corporate resolution authorizing the change and then the drafting of the appropriate documents as follows:

New split-dollar loan agreement;

Demand of term note;

Collateral assignment; and,

IRS written representation letter (for a premium loan that is nonrecourse to the borrower).

In the case of nonrecourse loans, the proposed regulations indicate that the parties (lender and borrower) must file a signed written representation that a reasonable person would expect that all payments under the loan would be made.

The regulations provide that until the Commissioner prescribes otherwise, both taxpayers must sign the representation not later than the last day (including extensions) for filing the federal income tax return of the borrower or lender, whichever is earlier.

The regulations provide that the signed written representation must include the names, addresses and taxpayer identification numbers of the borrower, lender and any indirect participants.

Finally, the regulations provide that the representation be filed with the federal income tax return of the lender and borrower for any taxable year in which the lender makes a loan to which the representation applies.

Once again, the final regulations do not extend the Dec. 31, 2003, safe harbor deadline for pre-Jan. 28, 2002, equity established in Notice 2002-8. Therefore it is incumbent upon financial professionals to act to review their affected clients cases.

, JD, CLU, ChFC, is vice president, marketing, for Prudential Insurance Company of America, Newark, N.J. She can be reached at [email protected].

Reproduced from National Underwriter Life & Health/Financial Services Edition, November 7, 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.