4030 / What is reverse split dollar and how is it taxed?

Reverse split dollar is a variation on the split dollar arrangement ( Q 4022) in which the ownership of the policy cash value and death proceeds is split between a corporation and an insured employee, but the traditional roles of the two parties to the arrangement are reversed. In the typical reverse split dollar plan, an employer pays a portion of the policy premium equal to the annual P.S. 58 cost or the Table 2001 cost each year while the difference between this cost and the full premium is contributed by the employee. Notice 2002-59¹ is believed to have ended the viability of reverse split dollar.

In Notice 2002-59, the IRS stated that a party to a split dollar arrangement may use Table 2001 or an insurer’s rates only for the purpose of valuing current life insurance protection when the protection is conferred as an economic benefit by one party on another party, determined without regard to consideration or premiums paid by the other party. Thus, if one party has the right to current life insurance protection, neither Table 2001 nor an insurer’s rates can be used to value that party’s insurance protection for purposes of establishing the value of policy benefits to which another party may be entitled.

Notice 2002-59 provides one example where the premium rates are properly used and one where they are not properly used. In the first example, a donor is assumed to pay the premiums on a life insurance policy that is part of a split dollar arrangement between the donor and a trust, with the trust having the right to the current life insurance protection. The current life insurance protection has been conferred as an economic benefit by the donor on the trust and the donor is permitted to value the life insurance protection using either Table 2001 or an insurer’s lower term rates.

In the second example, if the donor or the donor’s estate has the right to the current life insurance protection, neither Table 2001 nor an insurer’s lower term rates may be used to value the donor’s current life insurance protection to establish the value of economic benefits conferred on the trust. Results will be similar if the trust pays for all or a portion of its share of benefits provided under the life insurance arrangement.

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Planning Point: Notice 2002-59 does not contain an effective date, which indicates that the IRS does not consider it new guidance but a restatement by the IRS of current law. If that is the case, it will affect reverse split dollar arrangements that were in place before the notice was issued.

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