Split-Dollar Life Insurance Arrangements

A1.What a split-dollar arrangement is

Part 18, ch. 2, § A1

Under the general definition, a split-dollar life insurance arrangement is any arrangement between an owner and a non-owner of a life insurance contract that meets three tests: (i) either party pays all or part of the premiums, directly or indirectly, including by a loan secured by the contract; (ii) at least one premium-paying party is entitled to recover all or part of those premiums, conditionally or unconditionally, from the policy proceeds or with the proceeds as security; and (iii) the arrangement is not part of a §79 group-term plan, unless that plan provides permanent benefits. Final reg: Treas. Reg. §1.61-22(b)(1). Two special rules extend the definition. A compensatory arrangement is split-dollar regardless of the general definition if it is entered into in connection with services, is not part of a §79 plan, the employer pays any part of the premiums, and the employee either names (or would be expected to name) a beneficiary of any part of the death benefit or has any interest in the policy cash value. A corporation–shareholder arrangement is covered on parallel terms. Final reg: Treas. Reg. §1.61-22(b)(2)(ii)–(iii). Pure key-person coverage — the company owns the policy and keeps all of the death benefit and all of the cash value — is outside both the general and the special rules. Preamble: T.D. 9092, 68 Fed. Reg. at 54337. Final reg: Treas. Reg. §1.61-22(c)(1)(i), (c)(4).

A2.Ownership picks the regime

Part 18, ch. 2, § A2

The two regimes are mutually exclusive. Paragraphs (d)–(g) of §1.61-22 (the economic benefit regime) apply, and §1.7872-15 does not, when a compensatory arrangement has the employer as owner. Final reg: Treas. Reg. §1.61-22(b)(3)(ii)(A). Otherwise, a payment that meets the loan definition is a split-dollar loan governed by §1.7872-15 (C1). Final reg: Treas. Reg. §1.61-22(b)(3)(i). The owner is generally the person named as policy owner; when two people are named and neither holds every incident of ownership in an undivided interest, the first-named owner is the owner of the whole contract. Final reg: Treas. Reg. §1.61-22(c)(1)(i). Three rules can override the name on the policy:

• Non-equity override. The employer is treated as owner, whoever is named, if at all times the only economic benefit is current life insurance protection. A non-equity collateral-assignment arrangement with the executive named as owner therefore still falls under the economic benefit regime. Final reg: Treas. Reg. §1.61-22(c)(1)(ii)(A)(1).
• Attribution. The employer is treated as owner if the named owner is a §402(b) (secular) trust, a grantor trust treated as owned by the employer, a §419(e) welfare benefit fund, or a member of the employer's §414(b) controlled group or §414(c) common-control group. Final reg: Treas. Reg. §1.61-22(c)(1)(iii). The preamble confirms that the grantor-trust rule reaches a rabbi trust. Preamble: 68 Fed. Reg. at 54338.
• Consistency. The owner and the non-owner must treat the arrangement the same way under the same regime and must account fully for all amounts. Final reg: Treas. Reg. §1.61-22(b)(4).

Treasury's own description is that the parties "effectively have the ability to elect which regime will apply" by choosing who to name as owner. Preamble: 68 Fed. Reg. at 54338.

A3.Effective date, "entered into," and material modification

Part 18, ch. 2, § A3

Both regulations apply to arrangements entered into after September 17, 2003. Final reg: Treas. Reg. §§1.61-22(j)(1)(i), 1.7872-15(n)(1). An arrangement is entered into on the latest of five dates: the contract issue date, the contract effective date, the first premium payment, the date the parties sign the agreement, or the date the arrangement first meets the definition. Final reg: Treas. Reg. §1.61-22(j)(1)(ii). A pre-September 18, 2003 arrangement that is materially modified after September 17, 2003 is treated as new on the modification date. Final reg: Treas. Reg. §1.61-22(j)(2)(i). The regulation lists changes that are not material modifications; the list is non-exclusive:

• a change solely in the premium mode;
• a beneficiary change, unless the beneficiary is a party to the arrangement;
• a change in the policy-loan interest rate;
• a change needed to preserve §7702 status;
• ministerial changes;
• non-discretionary changes made under a binding commitment in effect on or before September 17, 2003;
• a §381(a) successor-owner change;
• insurer-insolvency changes required by a court or insurance commissioner; and
• an assumption-reinsurance change of administering insurer.

Final reg: Treas. Reg. §1.61-22(j)(2)(ii). Rev. Rul. 2003-105 made Rev. Ruls. 64-328, 66-110 (except as provided in Notice 2002-8, Part III.3, and Notice 2002-59, 2002-36 I.R.B. 481), 78-420, and 79-50 obsolete for arrangements entered into or materially modified after September 17, 2003. Taxpayers may keep relying on those rulings, to the extent Notice 2002-8 allows, only if the arrangement has not been materially modified. Rev. Rul.: Rev. Rul. 2003-105, 2003-40 I.R.B. 696. For a grandfathered arrangement, Notice 2002-8 provides four rules:

• Equity build-up is not a transfer. For arrangements entered into before the final regulations were published, cash surrender value growing past the employer's share is not by itself a §83 transfer. IRS Notice: Notice 2002-8, 2002-1 C.B. 398, Part IV.1.
• No deemed termination. The IRS will not treat the arrangement as terminated, or assert a transfer of property on termination, for as long as the parties keep reporting the value of the protection as an economic benefit. IRS Notice: Notice 2002-8, Part IV.2.
• Optional loan treatment. The parties may treat the sponsor's payments as loans. IRS Notice: Notice 2002-8, Part IV.3.
• Pre-January 28, 2002 arrangements with full repayment. This rule is available only where the sponsor "has received or is entitled to receive full repayment of all of its payments." If so, the IRS will not assert a taxable transfer on termination in either of two cases. The first is a termination before January 1, 2004. The second is that, for all periods beginning on or after January 1, 2004, all sponsor payments from inception (net of repayments) are treated as loans and reported consistently under §§1271–1275 and 7872. Pre-loan-treatment payments are treated as loans made at the start of the first loan year. IRS Notice: Notice 2002-8, Part IV.4.

The preamble adds that a change made solely to comply with Part IV.4 of Notice 2002-8 is not a material modification. Preamble: 68 Fed. Reg. at 54343–44. Practitioner consensus. Under the economic benefit regime that can expose the cash-value build-up the grandfather had sheltered. Before signing an amendment to a pre-2003 arrangement, check Notice 2007-34's §409A modification relief (D2).