327 / Are proceeds of life insurance under a split dollar plan or under a reverse split dollar plan includable in an insured’s gross estate in the context of an employer-employee relationship?

It should be noted that the term “reverse split dollar” is not contained in the split dollar regulations. Once a common term, today it is still sometimes used to define arrangements where the employee owns the policy and endorses the death benefit to the employer – instead of the more typical arrangement where the employer owns the policy and endorses the death benefit to the employee or a beneficiary named by the employee. See also IRS Notice 2002-59, which addresses the valuation of term insurance under a so-called reverse split dollar arrangement.

In Schwager v. Commissioner,¹ a sole proprietor applied for and owned a policy on a split dollar or endorsement plan on the life of an employee. The beneficiary of proceeds equal to the cash value at death was designated in the policy as the part A beneficiary and in this case was the employer. The beneficiary of proceeds in excess of the cash value, the part B beneficiary, was the employee’s wife. By policy amendment, the part B beneficiary could not be changed without the insured’s consent. The Tax Court decided that the insured’s right to consent to a change of beneficiary was an incident of ownership and held that the portion of proceeds paid to his widow was includable in his estate. The opinion does not make it clear that only the portion of proceeds payable to the insured’s widow was includable in the estate, but counsel for the taxpayer has confirmed that was the case. Apparently, the IRS did not try for the includability of more.

In Estate of Tomerlin v. Commissioner,² a corporation owned insurance on the life of a decedent, a 50 percent shareholder of the corporation. The policy provided that the corporation was the sole owner of the policy and that the death proceeds were to be divided between the corporation and the decedent’s children. The corporation was to receive the proceeds equal to the premiums it had paid and the decedent’s children were to receive the balance. The decedent had been given incidents of ownership in the policy by agreement with the corporation, including the right to designate beneficiaries of the policy. The IRS sought includability in the decedent’s estate under IRC Section 2042(2) of the portion of the proceeds payable to the decedent’s children, and the court found for the IRS.