Split Dollar Plan

March 13, 2024

4022 / What is a split dollar plan?

<div class="Section1"> Split dollar insurance is an arrangement that often exists between an employer and an employee under which policy benefits are split and the premiums may be split. Split dollar plans also can be set up between corporations and shareholders (“shareholder split dollar”) or between parents and their children (“private split dollar”). <hr> Planning Point: In 2021, the Tax Court ruled in favor of taxpayers who used a private split-dollar strategy in estate planning. In Morrissette v. Commisioner, T.C. Memo 2021-60 (May 13, 2021), a parent purchased life insurance on her sons’ lives – the policies were technically purchased through revocable “dynasty” trusts —for $29.9 million (premium costs). When she died, her reimbursement rights under these “split-dollar” arrangements were valued at only $7.5 million, because the policies would not pay out until the sons died at some future date. Essentially, the strategy is valuable because the difference between the two values is a tax-free gift. The IRS argued that a fair market valuation approach must be used in split-dollar cases, which would assign the much higher premium cost to the value of the policies using the logic typically applied to buy-sell arrangements in family businesses. The Tax Court instead found that the economic benefit theory of split-dollar could be applied, a result that favored the estate. <hr> A similar case, Cahill v. Commissioner, T.C. Memo. 2018-84 (June 18, 2018), was settled out of court in 2018. For years, the premium was often split, with the employer paying the cost of annual term coverage, and the employee paying the balance. Under this arrangement, the employer received from the proceeds an amount equal to the cash value of the policy or at least its premium payments, and the employee’s beneficiary received the balance of the proceeds. From this basic concept, hybrid plans evolved. For example, there are “employer pay all” plans under which an employer pays the entire premium and “level contribution” plans under which an employee pays a level amount each year. There also are reverse split dollar plans ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4030">4030</a>) and charitable split dollar plans ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="121">121</a>). A split dollar arrangement may be in the form of an endorsement plan where an employer owns a policy and the benefit-split is provided by endorsement, or a collateral assignment plan under which an employee owns the policy and the employer’s interest is secured by collateral assignment of the policy. The Sarbanes-Oxley Act of 2002<a href="#_ftn1" name="_ftnref1">1</a> generally prohibits direct or indirect loans to certain executive officers and directors of public companies. After passage of the Sarbanes-Oxley Act, there is now a question of whether it is legal for a publicly traded company to set up a split dollar plan or to continue paying premiums on an already existing plan. Many publicly traded companies have stopped paying premiums on split dollar plans. <hr> Planning Point: Most practitioners are comfortable that endorsement plans (whereby the employee merely rents current death benefit converge) do not violate the Sarbanes-Oxley Act’s prohibition against indirect loans. However, collateral assignment arrangements are regarded as more problematic. Some companies are instead paying bonuses to employees covered by split dollar plans so that the employees can pay the premiums themselves. <hr> Plans Entered Into After September 17, 2003 Treasury regulations issued in 2003 define a split dollar life insurance arrangement as any arrangement between an owner and a nonowner of a life insurance contract satisfying the following criteria: (1)  either party to the arrangement pays all or a portion of the premiums on the life insurance contract, including payment by means of a loan to the other party that is secured by the life insurance contract; (2)  at least one of the parties to the arrangement that is paying premiums is entitled to recover all or a portion of the premiums and the recovery is to be made from or secured by the proceeds of the life insurance contract; and (3)  the arrangement is not part of a group term life insurance plan unless the plan provides permanent benefits.<a href="#_ftn2" name="_ftnref2">2</a> Certain compensatory arrangements and shareholder arrangements are treated as split dollar arrangements even if they do not meet the general definition of a split dollar arrangement. A compensatory arrangement is one where: (1)  the arrangement is entered into in connection with the performance of services and is not part of a group term life insurance plan; (2)  the employer pays all or a portion of the premiums; and (3)  either (x) the beneficiary of any portion of the death benefit is designated by the employee or is a person the employee would reasonably be expected to designate as a beneficiary, or (y) the employee has any interest in the cash value of the policy. The definition of a shareholder agreement is similar, but with corporation substituted for employer and shareholder for employee.<a href="#_ftn3" name="_ftnref3">3</a> These definitions are effective for split dollar arrangements entered into after September 17, 2003, or split dollar arrangements entered into before September 18, 2003, that are materially modified after September 17, 2003 ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4023">4023</a>).<a href="#_ftn4" name="_ftnref4">4</a> Plans Entered into Before September 18, 2003 The following discussion applies to split dollar plans entered into before September 18, 2003. If a transaction is cast in a form that results in similar benefits to an employee as in a traditional split dollar plan, it will be treated as a split dollar plan.<a href="#_ftn5" name="_ftnref5">5</a> Thus, an arrangement dividing interests in a policy on an employee between the employer and the insured employee’s wife was ruled a split dollar plan providing a taxable economic benefit to the employee ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4027">4027</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="578">578</a>). Similarly, where an insured was the employee’s father, the plan was held to provide a benefit to the employee taxable as a split dollar plan.<a href="#_ftn6" name="_ftnref6">6</a> A split dollar plan between a corporation and an insured nonemployee shareholder was ruled to provide a taxable dividend to the shareholder.<a href="#_ftn7" name="_ftnref7">7</a> Other Considerations A split dollar arrangement offered as a fringe benefit to employees of an S corporation in which the employer agreed to pay the total premium less the term insurance cost did not violate the one class of stock restriction applicable to S corporations under IRC Section 1361(b)(1)(D).<a href="#_ftn8" name="_ftnref8">8</a> Similarly, a split dollar arrangement for shareholders in which the employer agreed to pay the full premium and the shareholders agreed to reimburse the employer for the economic benefit amount did not violate the one class of stock restriction.<a href="#_ftn9" name="_ftnref9">9</a> The cash values of policies in an endorsement-type split dollar plan that made use of an independent fiduciary to select the policies were not considered plan assets for purposes of ERISA.<a href="#_ftn10" name="_ftnref10">10</a> The IRS has issued guidance regarding the application of IRC Section 409A to split dollar life insurance arrangements. The notice also provides that certain modifications of split dollar life insurance arrangements necessary to comply with, or avoid application of, IRC Section 409A will not be treated as a material modification.<a href="#_ftn11" name="_ftnref11">11</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  P.L. 107-204. <a href="#_ftnref2" name="_ftn2">2</a>.  Treas. Reg. § 1.61-22(b)(1). <a href="#_ftnref3" name="_ftn3">3</a>.  Treas. Reg. § 1.61-22(b)(2). <a href="#_ftnref4" name="_ftn4">4</a>.  Treas. Reg. § 1.61-22(j). <a href="#_ftnref5" name="_ftn5">5</a>.  Rev. Rul. 64-328, 1964-2 CB 11. <a href="#_ftnref6" name="_ftn6">6</a>.  Rev. Rul. 78-420, 1978-2 CB 67. <a href="#_ftnref7" name="_ftn7">7</a>.  Rev. Rul. 79-50, 1979-1 CB 138. <a href="#_ftnref8" name="_ftn8">8</a>.  Let. Rul. 9248019. <a href="#_ftnref9" name="_ftn9">9</a>.  Let. Rul. 9318007, Let. Rul. 9331009. <a href="#_ftnref10" name="_ftn10">10</a>.  DOL Adv. Op. 92-22A. <a href="#_ftnref11" name="_ftn11">11</a>.  Notice 2007-34, 2007-17 IRB 996. See also T.D. 9321, 73 Fed. Reg. 19234, 19249 (4-17-2007) (IRC § 409A final regulations). </div></div>