4029 / What are the income tax consequences of the transfer or rollout of a policy subject to a split dollar arrangement entered into before September 18, 2003?

The IRS considered this issue in two private letter rulings. In the first private letter ruling, the split dollar plan provided that the insured employee would be entitled to a portion of the life insurance policy’s cash surrender value annual increase equal to the employee’s share of the annual premium. The employee’s portion of the annual premium was determined by a payment schedule which entitled the employee to a portion of the cash surrender value of the policy. The plan’s rollout provision stated that if the employee remained employed for a specified time, the policy then would be transferred to the employee without cost. The net cash value of the policy transferred to the employee at that time would equal the employee’s cumulative premium, or if greater, the cash surrender value less the employer’s cumulative premiums.

The IRS concluded that when the policy is transferred to the employee, the employee would have taxable income to the extent the cash value in the policy exceeded the amounts the employee contributed. The IRS reasoned that the cash surrender value would be property transferred in connection with the performance of services and therefore the amount exceeding the employee’s basis, that is, the employee’s contributions, immediately would be taxable under IRC Section 83. Under IRC Section 83(h), the employer would be entitled to a deduction equal to the amount included in the employee’s income. This deduction would be offset by the employer’s recognition of a gain equal to the amount received in excess of its basis. Further, the insured employee must include in income each year the annual P.S. 58 cost of life insurance protection the employee received, to the extent paid for by the employer.¹

The employee was not entitled to use the employee’s contributions to offset the employer-provided insurance protection. The ruling does not indicate how the amount of protection provided by the employer is calculated, but it has been suggested that the calculation should be made in a manner consistent with Revenue Ruling 64-328.²