F—Corporate Split Dollar and Roll-Out

Corporate split dollar is a company sponsored benefit in which the company offers life insurance coverage to a key employee. Generally, there are two ownership set-ups in corporate split dollar:
• Collateral Assignment in which the employee owns the policy and the employer helps fund the policy by loaning the employee the premiums. The two primary ways to structure the split dollar loan in a collateral assignment split dollar arrangement are discussed below. Generally, the premiums are paid by the employer annually and the policy values are collaterally assigned to the employer. The plan ends either at death, retirement or some other date (referred to as roll-out or exit), at which point the employer is repaid using the policy values, or a combination of policy values and out of pocket funds. In some cases, it is also possible for the loan repayment to be bonused or forgiven, in which case the employee will recognize income tax on the value of the bonus or forgiveness.
• Endorsement in which the company owns and pays for the policy on the life of a key employee and endorses or “rents” the death benefit to the employee for the term cost of the death benefit, which is significantly less than the full premium on a cash value policy. In the endorsement plan, the company may retain a portion of the death benefit to indemnify itself from the loss of that employee, typically a key contributor to the business. It is possible for the employer to transfer the policy to the employee at some point in the future, such as at retirement. The employee would then pay income tax on the value of the policy, the calculation of which is based on the policy’s cash value at the time of the transfer. Sometimes the employer will “bonus” the value of the policy, in which case the employee will recognize income tax on the value of the policy in the year of transfer. Alternatively, the employer may provide the funds to pay the taxes in the form of an additional bonus. This latter structure is referred to as a double bonus.

Corporate Collateral Assignment Split Dollar. In collateral assignment split dollar, there are two general ways to set-up the plan. The employer makes a loan of the premium to the key executive on a life insurance policy that covers the employee’s life. The policy is owned by the employee and a portion of the death benefit and policy cash value is collaterally assigned to the employer to ensure repayment.

Economic Benefit Regime vs. Loan Regime vs. Switch Dollar (Hybrid). The structure of a collateral assignment split dollar plan has evolved over the years due to changes in regulations that govern split dollar arrangements. Generally, the employee purchases and owns a cash value policy on their life and the employee either pays the term cost of the death benefit (which is less than the full premium), or, in most cases, the employer pays the full premium including the term cost. In the latter case (referred to as economic benefit split dollar), the employee includes the term cost in their income every year since that is considered “imputed income.”

Instead of an economic benefit split dollar, the split dollar plan can be structured as a loan regime split dollar, especially useful in a low interest rate environment. The annual cost of the  lan is the loan interest payments, based on a fair market rate of interest (using Applicable Federal Rates (AFR) published by the government monthly). The loan interest is calculated by applying the AFR rate annually to the cumulative premiums paid by the employer. The AFR rate can be locked for a term of years or it can change annually. See below discussion of term and demand notes for more information.

In either collateral assignment plan (economic benefit or loan regime) the employee collaterally assigns a portion of the policy’s accumulated cash value and death benefit to the employer until the cumulative premium loan is repaid to the employer (either at death, retirement or a specified date. This is referred to as the roll-out or split dollar exit. See below for
further discussion of roll-out).

Each structure (economic benefit or loan regime) has rules governed by the final regulations discussed below in the History section) with respect to the collateral assignment of the cash value. Briefly, in an economic benefit split dollar plan, the death benefit that is collaterally assigned is the cumulative premiums paid. If the employee dies before the split dollar is rolledout
(loan repaid and split dollar terminated), the death benefit repays the loan. However, when it comes to the collateral assignment of the cash value, it is a different situation. The amount of the policy cash value collaterally assigned to the employer in an economic benefit regime must be the greater of policy cash value or cumulative premiums paid. This means that if the cash value exceeds the cumulative premiums paid when the loan is due to be repaid, then the full cash value of the policy goes to the employer. This means more than what the employer paid inures to the benefit of the employer, and not the employee, and depending on the extent of the cash value growth, can strip the benefits of establishing a split dollar plan; a withdrawal or loan of policy cash value to repay the employer during lifetime will decrease the death benefit. Moreover, prior to the changes in the split dollar rules from the final split dollar regulations issued in 2003, the excess cash value above the cumulative premiums paid, inured to the benefit of the employee and was referred to as equity split dollar. In other words, the employee benefited from the gain in the policy. The final regulations now prohibit the excess equity to inure to the benefit of the employee without the excess being included in the employee’s income for tax purposes. In other words, only non-equity split dollar is allowed if the employee wants to avoid being income taxed on the excess equity above the cumulative premiums paid by the employer.

The final split dollar regulations allow equity split dollar only through a loan regime split dollar plan. That is, the collateral assignment of the policy cash value and the death benefit are based on the cumulative premiums paid. This means, when the cash value of the policy exceeds the cumulative premiums, it inures to the benefit of the employee, and not the employer. Since 2025, the employee is paying loan interest annually on the cumulative premiums paid, excess equity that the employee benefits from is not included in the employee’s income. Therefore, given the extended low interest rates of the last fifteen years, many corporate split dollar plans have been structured as loan regime split dollar. With interest rates climbing, a hybrid structure referred to as switch dollar has evolved.

Switch dollar split dollar establishes an economic benefit split dollar upfront (non-equity split dollar). Once the policy’s cash value reaches cumulative premiums paid, the arrangement is terminated and replaced with a loan regime split dollar plan (equity split dollar). This “switch" allows the collateral assignment for cash value purposes to be cumulative premiums paid with the excess cash value inuring to the benefit of the employee.

History of Split-Dollar. Under a split-dollar plan the term “equity split-dollar” is derived from the employee’s interest
in policy cash values (i.e., the employee has an “equity” interest). By sharing the ownership of cash values and limiting the employer’s interest in the policy to its cumulative premium payments it was often possible for the employee to accrue substantial interests in the remaining cash values, with little or no adverse income taxation.

Until the final split-dollar regulations issued in 2003 there had been a great deal of uncertainty surrounding the tax treatment of equity split-dollar. However, Notice 2002-8 (issued in January of 2002) and proposed regulations (REG-164754-01 released in July of 2002) appeared to provide workable transition rules, safe harbors, and limited grandfathering of existing plans. The final split-dollar regulations (Treasury Decision 9092 issued in September of 2003) generally adopted the proposed regulations and dramatically altered the tax treatment of split-dollar plans. The tax treatment of new split-dollar plans is now governed by policy ownership.

Plans Established Prior To September 18, 2003. To better understand the transition rules for existing split-dollar plans and the application of the regulations to new split-dollar plans, it is helpful to break plans out according to the date
they were entered into: 

1. In split-dollar plans entered into before January 28, 2002, and terminated before January 1, 2004, the employee’s equity will not be taxed. In split-dollar plans entered into before January 28, 2002, and terminated on or after January 1, 2004, the employee’s equity will not be taxed, provided the plan was converted to a loan from the employer to
   the employee for all periods beginning on or after January 1, 2004 (if the plan was not converted to a loan, the employee will be taxed on all equity if the plan is eventually terminated). See table in section 4.9[E], Split Dollar Insurance).


2. In split-dollar plans entered into on or after January 28, 2002 and before September 18, 2003, if the plan was not converted to a loan the employee is subject to taxation on all equity in excess of the employee’s basis when the plan is terminated (employee basis does not include amounts reported or paid for life insurance protection). But if the plan was not terminated the employee will not be currently taxed on equity as it builds up, provided the employee continues to report the receipt of the economic benefit and the employer retains some economic interest in the policy. 

Plans Established After September 17, 2003. In split-dollar plans entered into after September 17, 2003 (or prior plans that are “materially modified”) taxation of employee equity depends upon how the plan is structured. Based upon policy ownership the split-dollar regulations use a formalistic, yet straight forward, approach in providing two “mutually exclusive regimes” (or methods) for the taxation of splitdollar plans.

Economic Benefit Regime. This regime applies when the employer owns the contract and the employee’s death benefit is accomplished by a policy endorsement (known as endorsement split-dollar). By exception this regime also applies when the employee owns the contract but the employer owns all cash values. In addition to being taxed for the value of the life insurance protection (i.e., the “economic benefit” as imputed income), the employee is also taxed on any increased interest in policy cash values (not just at rollout). Also, if the policy is subsequently transferred from the employer to the employee
the employee is taxed on any employer equity. The employee’s basis in the policy is equal to the amount paid at the time of transfer, but does not include amounts that had been taxed to the  employee on account of prior increases in policy cash values and amounts reported or paid for life insurance protection. Any premium amounts contributed by the employee are taxable income to the employer. Given these harsh rules it is doubtful whether the employee should be given an equity interest in plans established and taxed under the economic benefit regime. However, nonequity endorsement plans taxed under the economic benefit regime avoid many of these adverse tax consequences.

Loan Regime. This regime applies when the employee owns the contract and collaterally assigns the policy cash values to the employer in order to secure repayment of the employer’s premium advances (known as collateral assignment split-dollar). Because the employee already owns the policy and is obligated to repay any employer loans the employee is not taxed on the equity interest in policy cash values.

Each premium payment by the employer is treated as a separate loan to the employee (“deemed loan” in the chart below). If the employee fails to pay an adequate rate of interest, they are classified as below-market split-dollar loans and the employee is considered to have received compensation equal to the foregone interest (taxable to the employee and deductible by the
employer). This foregone interest is then imputed back to the employer (taxable to the employer but not deductible to the employee since it is considered personal in nature). The complexity of loan regime taxation, as illustrated in the following chart, should be compared with the simplicity of economic benefit regime taxation.