Estate Planning Split-Dollar (Collateral Assignment) by hft13158

VIEWS: 0 PAGES: 18

									                                                                                              Estate Planning Split-Dollar
                                                                                                       (Collateral Assignment)



                                                                               The Company You Keep®                                                           August • 2005


Concept Analysis

  Split-Dollar Life Insurance ..................1                          Split-Dollar Life Insurance                            into” after September 17, 2003.2 This
                                                                                                                                  article addresses these arrangements.
  Scope of Article .....................................1
                                                                           A split-dollar life insurance arrangement is
  History ...................................................1                                                                    Generally, IRS Notice 2002-8 will control
                                                                           an arrangement between two people by
  Split-Dollar and Gross Income............2                               which life insurance is written on the life            the tax treatment of split-dollar
  Date “Entered Into”....................................... 2             of one, though both share the premium                  arrangements “entered into” before
  Material Modification ................................... 2              payments.1 This is a method for funding a              September 18, 2003 (pre-final regulation).
  Basic Definitions ...................................3                   life insurance policy, not a type of life              These pre-final regulation arrangements
  Split-Dollar Life Insurance............................ 3                insurance protection.                                  are not addressed in any detail in this
  Collateral Assignment Split-Dollar ............... 3                                                                            article, but a brief review of the history of
                                                                           Estate planning split-dollar is an                     split-dollar is offered as a starting
  The Two Regimes: “Economic
                                                                           arrangement where the insured has                      foundation.
  Benefit” and “Loan”.............................3
  “Owner” and the Applicable “Regime”......... 4                           acquired a policy to meet estate planning
  Economic Benefit Regime ............................ 4                   needs, and is funding the policy under a               History
                                                                           split-dollar arrangement. The policy may
  Loan Regime ................................................. 4
                                                                           be owned by the insured, a family                      The split-dollar approach to funding life
  Collateral Assignment Under Either Regime 4
                                                                           member, or a trust, depending on the                   insurance premiums has developed amidst
  The Economic Benefit Regime.............4                                insured’s unique needs. The funding may                uncertainty       in   its    income    tax
  Treatment of the Economic Benefit .............. 4                       be provided by the insured’s employer, a               consequences. The tax history of the split-
  Contributory .................................................. 4        corporation of which the insured is a                  dollar approach began in 1955 with the
  Non-Contributory.......................................... 4             shareholder, or a family member of the                 IRS’s release of Revenue Ruling 55-713
  Determining Economic Benefit..................... 5                      insured.                                               where it took the position that split-dollar
  Current Life Insurance Protection ................. 5                                                                           was an un-taxed, interest-free loan. In the
  Calculating Cost of Protection ...................... 5                  For simplicity, references used in                     1961 Dean case,3 the IRS changed
  Death Benefit Taxation ................................. 5               discussion and examples in this article will           positions and argued that the interest was
  Termination of Arrangement During                                        generally be made in terms of a typical                taxable. Even though the court ruled
  Insured’s Life ................................................ 6        estate planning arrangement where the                  against the IRS, this clear change of
  The Loan Regime..................................9                       insured’s trust is the actual owner of the             position brought uncertainty to the
  Applicable Loan Rules.................................... 9
                                                                           policy, and the insured’s employer is the              planning community. In 1964, the IRS
                                                                           funding party.                                         released Revenue Ruling 64-328, revoking
  Below-Market Demand Loans......................... 9
                                                                                                                                  Revenue Ruling 55-713 and clarifying
  Below-Market Term Loans ........................... 10
                                                                           Scope of Article                                       income and gift tax consequences by
  Imputed Interest Taxation.............................. 12                                                                      introducing the concept of the economic
  Death Benefit Taxation ................................. 12                                                                     benefit of life insurance protection.
                                                                           On September 11, 2003, the IRS issued
  Termination of Arrangement During Insured’s
  Life .............................................................. 12   regulations for the tax treatment of split-
                                                                           dollar life insurance arrangements “entered            The     early    “classic”    split-dollar
  Accrued and Forgiven Interest....................... 12                                                                         arrangement was based on the employer
  Choice of Regimes...............................16                                                                              paying the premium up to the increase in
  Switching Regimes..............................16                                                                               cash surrender value, with the remaining
  Reasons to Change Regimes ....................... 16
  Split-Dollar Arrangements & ERISA .17                                    1
                                                                             Black’s Law Dictionary (8th ed. 2004) (under
  Summary .............................................18                                                                         2
                                                                           definition for Life Insurance).           A more         Treas. Reg. §§ 1.61-22, 1.83-1(a)(2), 1.83-
                                                                           technical, regulation-based discussion of the          3(e), 1.83-6(a)(5), 1.301-1(q), 1.7872-15
                                                                                                                                  3
                                                                           definition of split-dollar is included later in this     Dean v. Commissioner of Internal Revenue,
                                                                           article.                                               35 T.C. 1083 (1961).
             For informational purposes only. Neither New York Life nor its agents are in the business of providing legal, tax or accounting advice.
                                Please consult with your own professional advisors to learn more about your particular situation.
                                                                         Page 1 of 18
                                                                                                                                         36920 AU (exp 7/07)
                                                                                             Estate Planning Split-Dollar (Collateral Assignment)


premium paid by the policy owner.4 Later,           Date “Entered Into”                                  2. a change solely in the beneficiary of the
the equity split-dollar arrangement5 grew                                                                   life insurance contract, unless the
more widespread than the classic                    These relatively new rules are applicable               beneficiary is a party to the arrangement,
arrangement. Although very common,                  to split-dollar life insurance arrangements
there was still concern and debate on               “entered into” after September 17, 2003.7            3. a change solely in the interest rate payable
whether the equity accumulation in the              The date a new arrangement is entered into              under the life insurance contract on a
policy was taxable under the income tax             is the latest of the following:                         policy loan,
rules (and gift tax rules if there was a
third-party owner.)                                 1. the date on which the life insurance              4. a change solely necessary to preserve the
                                                       contract under the arrangement is issued,            status of the contract under IRC § 7702,11
This debate came to an end with the
release of IRS Notices 2001-10 and 2002-            2. the effective date of the life insurance          5. a change solely to the ministerial
8, followed by guidance in proposed and                contract under the arrangement,                      provisions of the life insurance contract,
then final treasury regulations. It is now
clear from these notices and regulations            3. the date on which the first premium on the        6. a change made solely under the terms of
that equity accumulation can’t be built                life insurance contract under the                    any agreement (other than the life
from interest free premium advances while              arrangement is paid,                                 insurance contract) that is a part of the
avoiding income taxation.                                                                                   split-dollar life insurance arrangement if
                                                    4. the date on which the parties to the                 the change is non-discretionary by the
Split-Dollar and Gross Income                          arrangement enter into an agreement with             parties and is made pursuant to a binding
                                                       regard to the policy, or                             commitment (whether set forth in the
IRC § 61 provides a non-exclusive list of                                                                   agreement or otherwise) in effect on or
items that are included in a taxpayer’s             5. the date on which the arrangement                    before September 17, 2003,
gross income. The treasury regulations                 satisfies the definition of a split-dollar life
under § 61 provide further guidance as to              insurance arrangement (as defined in the          7. a change solely in the owner of the life
what must be included and have been                    regulation).8                                        insurance contract as a result of a
updated with regulation § 1.61-22 that                                                                      transaction to which § 381(a)12 applies and
provides the rules for the tax treatment of                                                                 in which substantially all of the former
                                                    Material Modification
split-dollar life insurance arrangements.6                                                                  owner’s assets are transferred to the new
                                                                                                            owner of the policy,
                                                    A split-dollar arrangement entered into
                                                    before September 18, 2003 will generally
                                                                                                         8. a change to the policy solely if such
                                                    be subject to the rules under IRS Notice
                                                                                                            change is required by a court or a state
                                                    2002-8, but, “material modification” of the
4                                                                                                           insurance commissioner as a result of the
  References to a policy owner generally mean       arrangement can cause it to be controlled
                                                                                                            insolvency of the insurance company that
the party listed on the contract as owner of the    by the current split-dollar regulations
policy. The split-dollar regulations create an                                                              issued the policy, or
                                                    because of the definition of “entered into”.
extra meaning where another party might be          A pre-existing arrangement9 that is
treated as the owner for taxation purposes. Any                                                          9. a change solely in the insurance company
                                                    “materially modified” after September 17,
references in this article to the owner (or non-                                                            that administers the policy as a result of an
                                                    2003 is treated as “entered into” on the
owner) for split-dollar and tax purposes will be                                                            assumption      reinsurance      transaction
indicated by the use of quotation marks             date of the modification and thus subject
                                                                                                            between the issuing insurance company
(“owner” or “non-owner”) and references to the      to the new regulations.10 Even though the
                                                                                                            and the new insurance company to which
actual owner will be made explicitly.               basic idea of “entered into” seems clear,
                                                                                                            the owner and the non-owner were not a
5
   An arrangement whereby the owner of the          what constitutes a material modification is
                                                                                                            party.13
policy retains the right to all cash value in       not clearly defined in the regulation.
excess of premiums advanced by the sponsor.         Rather, a non-exclusive listing of non-
This excess amount is considered the owner’s        material modifications is provided. The              This list provides little more than a “feel”
equity. The sponsor is the party advancing the      non-material modifications listed in the             for the thinking behind what is considered
premiums; the employer, corporation, or donor.      regulation are:                                      non-material. From this list, it appears
6
  Treas. Reg. § 1.61-22, also referred to as the                                                         that the universe of changes that would be
“Final Regulations” for split-dollar arrange-                                                            considered material could be quite large.
ments. A pdf version of this regulation is
                                                    1. a change solely in the mode of premium
currently available at:                                payment (for example, a change from
http://a257.g.akamaitech.net/7/257/2422                monthly to quarterly premiums),                   11
/12feb20041500/edocket.access.gpo.gov/                                                                      IRC § 7702 defines “Life Insurance” under
cfr_2004/aprqtr/pdf/26cfr1.61-22.pdf.                                                                    the Internal Revenue Code.
                                                    7
Generally, the Code of Federal Regulations can        Treas. Reg. § 1.61-22(j)(1).                       12
                                                                                                            IRC § 381(a) provides the general rule for
                                                    8
be accessed at:                                       Treas. Reg. § 1.61-22(j)(1)(ii)                    carryovers in certain corporate acquisitions of
                                                    9
http://www.access.gpo.gov/nara/cfr/cfr-               established before September 18, 2003.             the assets of another corporation.
                                                    10                                                   13
table-search.html.                                     Treas. Reg. § 1.61-22(j)(2).                         Treas. Reg. § 1.61-22(j)(2)(ii).

 This is New York Life’s understanding of the generally applicable rules. Please understand New York Life, its agents or employees may not give legal or
                      tax advice. We recommend everyone seek and rely upon the advice of his or her own professional advisors.
                                                                     Page 2 of 18
                                                                                                Estate Planning Split-Dollar (Collateral Assignment)


Future cases and rulings will almost                   2. the employer pays any or all of the              Equity and Non-Equity Collateral
certainly expand and possibly clarify the                 premiums, and                                    Assignment Split-Dollar
definition of “material modification”, but
to avoid becoming part of one of those                 3. the employee names the beneficiary or has        When the fair market value17 of a policy
cases or rulings, any contemplated change                 any interest in the policy cash value.15         grows to the point that it exceeds the total
to a pre-final regulation arrangement                                                                      premiums advanced by the employer, the
should be carefully considered by the                  Shareholder Arrangements.                           amount of that excess is considered the
parties and their professional advisors.                                                                   “equity” in the contract. The distinction
                                                       An arrangement between a corporation                between an equity and non-equity
Basic Definitions                                      and another person not considering their            arrangement is based on who has the rights
                                                       employer/employee relationship can also             to that equity, not on whether it exists.
Split-Dollar Life Insurance                            be considered a split-dollar arrangement if:
                                                                                                           An equity collateral assignment split-
                                                       1. it is entered into between a corporation         dollar arrangement provides the employee
The split-dollar regulations provide
                                                          and another person in their capacity as a        the benefit of life insurance protection and
multiple definitions for exactly what is
                                                          shareholder in the corporation,                  rights to at least some portion of the equity
considered a split-dollar arrangement.
                                                                                                           in the contract. The employer’s rights are
                                                       2. the corporation pays any or all of the           restricted to something less than the full
Basic Definition
                                                          premiums, and                                    equity in the contract, often only a right to
                                                                                                           repayment of premiums advanced.
First, the basic definition of a split-dollar
life insurance arrangement is any                      3. the shareholder names the beneficiary or
                                                          has any interest in the policy cash value.16     In contrast, a non-equity collateral
arrangement between an owner and a non-
                                                                                                           assignment      split-dollar  arrangement
owner of a life insurance contract where:
                                                       Collateral Assignment Split-Dollar                  provides the employee the benefit of life
                                                                                                           insurance protection only, with no access
1. either party pays all or any portion of the
                                                       A collateral assignment split-dollar                to any other policy values. All rights
   premium,
                                                       arrangement is an arrangement under                 beyond the life insurance protection are
                                                       which the owner of the policy names the             assigned to the employer.
2. the payment is secured by the life
   insurance contract,                                 beneficiary, but assigns some portion of
                                                       the policy cash value and/or death benefit          The Two Regimes: “Economic
3. at least one of the parties is entitled to          as collateral to the party advancing part or        Benefit” and “Loan”
   recover payments from or the recovery is            all of the premium payments. A collateral
   secured by the proceeds of the policy, and          assignment split-dollar arrangement can be          A split-dollar arrangement is taxed under
                                                       entered into between various parties:               one of two “regimes”: either the
4. the arrangement is not part of a group-             employers and employees, or an                      “economic benefit regime”, or the “loan
   term life insurance plan under § 79 (unless         employee’s trust (a compensatory                    regime”.18 The regulations provide for the
   the plan provides permanent benefits).14            arrangement), private parties, (a donative          economic benefit regime tax treatment
                                                       arrangement known as private split-                 while also specifically carving out split-
The regulations then follow the basic                  dollar), or a corporation and its                   dollar loans to be taxed under the loan
definition with a special rule that applies            shareholder (a shareholder arrangement).            regime of Treasury Regulation § 1.7872-
even if the basic definition is not met.                                                                   15. The language of the regulations is
This special rule contains two additional,             Even though the rules apply generally to            such that an arrangement can only be
alternate definitions.                                 all these parties, this article will generally      taxed under either the economic benefit
                                                       be phrased in terms of arrangements                 regime or the loan regime, not both
Compensatory Arrangements.                             between an employer and its employee, or            simultaneously.19
                                                       the employee’s trust.
An arrangement             is       a   split-dollar
arrangement if:

1. it is entered into in connection with the                                                               17
   performance      of    services     in  a                                                                  The fair market value of a life insurance
   compensatory arrangement (again, not a §                                                                policy is determined under different rules,
                                                                                                           depending on the circumstances.          In an
   79 group-term life insurance plan),                 15
                                                            Treas. Reg. § 1.61-22(b)(2)(ii).               employment context, Revenue Procedure 2005-
                                                       16
                                                            Treas. Reg. § 1.61-22(b)(2)(iii).              25 will generally apply. In a gift tax context,
                                                                                                           Treas. Reg. § 25.2512-6 will generally apply.
                                                                                                           18
                                                                                                              Treas. Reg. § 1.61-22
14                                                                                                         19
     Treas. Reg. § 1.61-22(b)(1).                                                                             Treas. Reg. § 1.61-22(b)(3)

This is New York Life’s understanding of the generally applicable rules. Please understand New York Life, its agents or employees may not give legal or
                     tax advice. We recommend everyone seek and rely upon the advice of his or her own professional advisors.
                                                                           Page 3 of 18
                                                                                           Estate Planning Split-Dollar (Collateral Assignment)


“Owner” and the Applicable                          under the economic benefit regime. The              cumbersome actual vs. deemed owner
“Regime”                                            employee’s trust will be responsible for            language of the regulations.
                                                    paying for the economic benefit, or the
                                                    employee will be responsible for deemed             The Economic Benefit Regime
The “owner” of the policy can be used to
                                                    income and deemed gifts to the trust based
determine which regime applies for tax
                                                    on the trust receiving the economic benefit
purposes. If the policy is “owned” by the                                                               Treatment of the Economic Benefit
                                                    of the protection.
employer, the arrangement will be taxed
under the economic benefit regime. If it is                                                             Under the economic benefit regime, the
“owned” by the employee, or the                     If the policy is owned by the employer and
                                                                                                        employee’s trust receives the economic
employee’s trust, the arrangement will be           life insurance protection is all that is
                                                                                                        benefit of life insurance protection from
taxed under the loan regime.           But          provided      to   the    employee,      this
                                                                                                        the employer. The value of this economic
remember, these rules are for tax purposes          endorsement arrangement will also be
                                                                                                        benefit will be treated under the Internal
and the regulation provides for the concept         taxed under the economic benefit regime.
                                                                                                        Revenue Code according to the terms of
of a “deemed”20 owner.                              The employee will be responsible for
                                                                                                        the arrangement, the relationship between
                                                    paying for the economic benefit, or for the
                                                                                                        the parties, and any other exchange of
                                                    income tax consequences of receiving the
The actual ownership of the policy is first                                                             value.
                                                    economic benefit of the protection.
considered, followed by special tests:
                                                    Endorsement split-dollar arrangements are
                                                    covered in a separate article and will not          Contributory
1. If the split-dollar arrangement is
                                                    be discussed here in any further detail.
   entered into in connection with the                                                                  If the employee’s trust actually makes
   performance of services and if the only                                                              payment to the employer for the economic
                                                    To summarize, both collateral assignment
   economic benefit provided to the                                                                     benefit received, the arrangement is
                                                    and endorsement arrangements that
   employee is current life insurance                                                                   considered contributory. The payment for
                                                    provide only death benefit protection to
   protection, the employer will be                                                                     the economic benefit is made from the
                                                    the employee or the employee’s trust will
   “treated as the owner”.21                                                                            after-tax funds of the employee’s trust,
                                                    be taxed under the economic benefit
                                                    regime.                                             thus no additional taxation is required on
2. If the split-dollar arrangement is                                                                   the benefit received, but the payment does
   entered into between a donor and                                                                     not provide the employee’s trust an
   donee (private split-dollar) and only            Loan Regime                                         investment in the contract (basis).23
   current life insurance protection is
   provided to the donee, the donor will            The     loan     regime    in   split-dollar
                                                                                                        Even though the trust has no further
   be “treated as the owner”.22                     arrangements is where the premium
                                                                                                        income tax consequences, the payment
                                                    payments receive the tax treatment of
                                                                                                        received by the employer will be treated as
Economic Benefit Regime                             loans. If the policy is actually owned by
                                                                                                        taxable income, and to the extent the
                                                    the employee or the employee’s
                                                                                                        contribution is used to make premium
                                                    irrevocable trust, and the trust also has
If the policy is actually owned by the                                                                  payment, will be included as part of the
                                                    rights in the policy beyond the life
employee or the employee’s irrevocable                                                                  employer’s investment (basis).24       This
                                                    insurance protection, loan regime tax
trust, but the employer has all rights in the                                                           could happen if the employer advances
                                                    treatment will apply. The employee or the
policy cash value and the employee or the                                                               only the balance of the premium due
                                                    employee’s trust will be responsible for
employee’s trust only receives life                                                                     beyond the amount of the economic
                                                    the interest due on the premium loans.
insurance protection, the employer will be                                                              benefit paid by the employee’s trust.
“treated as the owner” for tax purposes                                                                 Considering these income tax and basis
and thus this “non-equity” collateral               Collateral Assignment Under Either                  rules, contributory arrangements may have
assignment arrangement will be taxed                Regime                                              limited appeal to the employee’s trust and
                                                                                                        the employee making the arrangement.
20
   deem, vb. 1. To treat (something) as if (1) it   From the above descriptions, you can see
were really something else, or (2) it had           that a collateral assignment split-dollar           Non-Contributory
qualities that it does not have. Black's Law        arrangement can be structured so that its
Dictionary (8th ed. 2004). " 'Deem' has been        tax treatment can fall under either the             If the employee’s trust receives the
traditionally considered to be a useful word        economic benefit regime or the loan                 economic benefit of the protection but
when it is necessary to establish a legal fiction   regime. A non-equity arrangement falls              doesn’t make actual payment for the
either positively by 'deeming' something to be      under the economic benefit regime and an
what it is not or negatively by 'deeming'
                                                                                                        benefit, the arrangement is considered
                                                    equity arrangement falls under the loan             non-contributory.    In this type of
something not to be what it is...." G.C.
                                                    regime.     This equity vs. non-equity
Thornton, Legislative Drafting 99 (4th ed.
1996).                                              distinction will generally be used for the
21
   Treas. Reg. § 1.61-22(c)(1)(ii)(A)(1).           remainder of the article rather than the            23
                                                                                                             Treas. Reg. § 1.61-22(f)(2)(i).
22                                                                                                      24
   Treas. Reg. § 1.61-22(c)(1)(ii)(A)(2).                                                                    Treas. Reg. § 1.61-22(f)(2)(ii).

This is New York Life’s understanding of the generally applicable rules. Please understand New York Life, its agents or employees may not give legal or
                     tax advice. We recommend everyone seek and rely upon the advice of his or her own professional advisors.
                                                                    Page 4 of 18
                                                                                           Estate Planning Split-Dollar (Collateral Assignment)


arrangement, the employee’s trust is               3. The value of any other economic benefit           In the year a split-dollar arrangement is
treated as having received the benefit from           beyond current life insurance protection          terminated, the valuation date will be the
the employer, through the employee.                   and cash value access.27                          date of termination, regardless of the date
                                                                                                        used in previous years of the
Employer/Employee’s Irrevocable                    In a true, non-equity collateral assignment          arrangement.32
Trust                                              arrangement, the only benefit generally
                                                   provided to the employee’s trust is the              Calculating Cost of Protection
If the employee’s irrevocable trust is the         value of the current life insurance
owner, the economic benefit will be                protection. The amount of cash value or              The cost of current life insurance
treated as compensation, taxable as income         other economic benefit available to the              protection is calculated by multiplying the
to the employee and deductible as an               employee’s trust will be zero.                       amount of that protection by a “life
expense to the employer, plus there will be                                                             insurance premium factor” established by
a deemed gift of the same amount from the          In an equity collateral assignment                   the Internal Revenue Service. Currently,
employee to the employee’s trust, with             arrangement, the employee’s trust will               that premium factor is published in IRS
associated gift tax issues.                        have access to cash value, but this type of          Notice 2002-8 in a table titled “Table
                                                   arrangement is taxed under the loan                  2001”.33 This table provides a cost factor
Employer/Employee                                  regime, described below.                             for each $1000 of death benefit protection
                                                                                                        for different ages.
If the owner is an employee, the economic          Thus, the focus for determination of the
benefit will be treated as compensation,           economic benefit under a non-equity                  Death Benefit Taxation
taxable as income to the employee and              collateral assignment arrangement will
deductible as an expense to the employer.          generally be item 1 above, the value of the
                                                                                                        Death benefit proceeds paid to the
                                                   current life insurance protection.
                                                                                                        employee’s trust that are attributable to the
Corporation/Shareholder                                                                                 economic benefit actually accounted for
                                                   Current Life Insurance Protection                    by the trust will be treated as an amount
If the owner is a shareholder in a                                                                      received under a life insurance contract
corporation that is advancing premiums on          In a non-equity collateral assignment                and will be excluded from gross income.34
the policy, the economic benefit will be           arrangement, the current life insurance
treated as a taxable dividend distribution,        protection provided to the employee’s trust          Any portion of the death benefit paid to
provided there are no other relationships          is the amount of the death benefit from the          the employee’s trust that exceeds the
that may also apply.                               policy that exceeds the amount payable to            amount attributable to the economic
                                                   the employer, reduced by any amount                  benefit accounted for will not be excluded
Donor/Donee (Private Split-Dollar)                 actually paid for by the trust.28 This               from income and will receive the
                                                   means the economic benefit amount that               appropriate tax treatment. For example, if
If the owner is a donee (insured or                has to be accounted for will be reduced if           the economic benefit for $100,000 of
insured’s trust), as in a private split-dollar     the trust pays all or part of the actual             death benefit was accounted for during the
arrangement, the economic benefit will be          premium.                                             arrangement, but the beneficiary was paid
treated as a gift from the donor to the                                                                 $120,000 at the insured’s death, the
donee.                                             The determination of the amount of life              $20,000 excess will be treated as
                                                   insurance protection and cash value is               compensation from the employer to the
Determining Economic Benefit                       made on the same date: the last day of the           employee and then a gift from the
                                                   employee’s trust’s tax year, unless the              employee to the trust.35
The value of the economic benefit                  parties agree to use the policy anniversary
provided to the owner equals the sum of:           date.29 Both parties must use the same
                                                   date, and the same date must be used
1. The cost of the current life insurance          throughout all years of the arrangement.30
   protection provided to the owner,25             This is subject to an anti-abuse provision           32
                                                   that, in the face of any artifice or device             Treas. Reg. § 1.61-22(d)(5).
                                                                                                        33
                                                   used to understate economic benefit, may                 This table is effective until replaced by
2. The amount of cash value to which the                                                                “future guidance” from the IRS.            No
   owner “has current access”, disregarding        cause the use of the value on the date that
                                                                                                        information is currently available regarding
   any surrender charges,26 and                    economic benefit is greatest.31                      potential future guidance. Notice 2002-8 was
                                                                                                        published January 28, 2002 in Internal Revenue
                                                   27                                                   Bulletin 2002-4, currently posted on the IRS
                                                      Treas. Reg. § 1.61-22(d)(2)(iii).                 web site at:
                                                   28
                                                      Treas. Reg. § 1.61-22(d)(3)(i)                    http://www.irs.gov/pub/irs-irbs/irb02-
                                                   29
                                                      Treas. Reg. § 1.61-22(d)(5).                      04.pdf
25                                                 30                                                   34
     Treas. Reg. § 1.61-22(d)(2)(i).                  Treas. Reg. § 1.61-22(d)(5)(ii).                       Treas. Reg. § 1.61-22(f)(3)(i), IRC § 101(a).
26                                                 31                                                   35
     Treas. Reg. § 1.61-22(d)(2)(ii).                 Treas. Reg. § 1.61-22(d)(5)(iii).                      Treas. Reg. § 1.61-22(f)(3)(iii).

This is New York Life’s understanding of the generally applicable rules. Please understand New York Life, its agents or employees may not give legal or
                     tax advice. We recommend everyone seek and rely upon the advice of his or her own professional advisors.
                                                                    Page 5 of 18
                                                                                           Estate Planning Split-Dollar (Collateral Assignment)


If operating under a private split-dollar          forgives some or all of what is owed, or a           employer to the employee will fall under
arrangement, the excess will be treated as         combination of payment and forgiveness is            the exception for transfers to the insured.
a gift from the donor.                             used to settle what is owed to the                   If the policy is owned by the employee’s
                                                   employer.                                            trust, the transfer, for income tax purposes,
Any death benefit paid to the employer as                                                               will still be treated as a transfer to the
beneficiary is excluded from income to the         Any amount that is paid back to the                  employee first, followed by a gift to the
extent that the amount is not allocable to         employer by the employee’s trust will be             trust. The transfer to the employee will
the death benefit protection taken into            non-deductible to the trust, who may use             fall under the exception just mentioned
account by the employee’s trust.36 For             liquid funds already in the trust, funds             and the gift to the trust is not a transfer for
example, if the death benefit paid to an           gifted into the trust by the employee, funds         value, but rather a gratuitous transfer.
employee’s trust is at least the amount            available from policy values, or any
attributable to the economic benefit               combination.                                         If Employer Becomes Owner After
accounted for by the trust, then the portion                                                            Termination
of the death benefit received by the               Any amount that is forgiven will have tax
employer is excluded from income.                  consequences, depending on the relation-             If the employer becomes the owner after
                                                   ship of the parties.                                 the termination of the arrangement, there
Termination of Arrangement                                                                              will be no further economic benefit
During Insured’s Life                              If the owner is the employee’s irrevocable           provided to the employee’s trust and thus
                                                   trust, the forgiven amount will be                   no further income or gift implications for
                                                   considered compensation to the employee              the trust. This type of termination can be
An      estate  planning   split-dollar
                                                   and includible in income taxes, then as a            called a “roll-in”.
arrangement taxed under the economic
benefit regime can be terminated by                gift from the employee to the trust, subject
agreement of the parties during the                to the gift tax rules.                               The employer will have taken ownership
insured’s life.                                                                                         of the policy as a return of the premiums
                                                   If the owner is an employee, the forgiven            advanced, and to the extent that the policy
                                                   amount will be considered compensation               cash value may exceed the premiums
The termination can be structured so that
                                                   to the employee and includible in income             advanced, will also have taxable income.
the employee’s trust remains the owner
after the termination, or so that the              taxes.39
employer becomes the owner at                                                                           To aid in understanding an estate planning
termination. The tax results will depend           If the arrangement is private split-dollar,          collateral assignment arrangement taxed
on who is the owner after the termination,         the forgiven amount will be considered a             under the economic benefit regime, the
the relationship of the parties, and other         gift from the sponsor40 to the owner.                basic arrangement is shown in diagrams
factors.                                                                                                below where the policy is owned by an
                                                   Any amount received by the sponsor will              employee’s irrevocable trust, but is treated
                                                   be considered a tax-free return of premium           as owned by the employer for income tax
If Trust Remains Owner After
                                                   advances, to the extent of actual advances           purposes, and the employer advances the
Termination
                                                   made, and as taxable income to the extent            premium payments. Two diagrams are
                                                   the payment exceeds premium advances.                shown to help distinguish between a non-
If, after the termination, the employee’s
                                                   E.g., if the policy fair market value has            contributory and a contributory arrange-
trust remains the owner and the employer
                                                   grown to an amount that exceeds the                  ment.
is no longer “treated as the owner”, then
the employer is treated as having made a           premium advances, then the amount owed
                                                   to the sponsor could exceed the actual               The diagrams assume the arrangement stays
transfer of the entire policy to the
                                                   premium advances.                                    in place until the death of the insured (no
employee and the employee is treated as
                                                                                                        roll-out) and policy death proceeds are used
having made a transfer to the trust.37
                                                   To the extent that the “transfer” of the             to pay the employer.
This form of termination has been called a         policy would be subject to the transfer for
“roll-out” and can be accomplished either          value rules, the exception for a transfer to
in a single payment to the employer, or as         the insured may apply.41 If the employee
a series of payments, and can include some         is the insured, transfer’s from the
degree of forgiveness38 from the obligation
by the employer. The employee’s trust              39
                                                       Treas. Reg. § 1.61-2(d)(2)(ii)(A). A pdf
simply pays back the employer what is              version of this regulation is currently available
owed under the arrangement, the employer           at:
                                                   http://a257.g.akamaitech.net/7/257/2422
                                                   /12feb20041500/edocket.access.gpo.gov/
36
   Treas. Reg. § 1.61-22(f)(3)(ii).                cfr_2004/aprqtr/pdf/26cfr1.61-2.pdf.
37                                                 40
   Treas. Reg. § 1.61-22(c)(1)(ii)(B)(2)                see footnote 5.
38                                                 41
   The release from a debt obligation.                  IRC § 101(a)(2)

This is New York Life’s understanding of the generally applicable rules. Please understand New York Life, its agents or employees may not give legal or
                     tax advice. We recommend everyone seek and rely upon the advice of his or her own professional advisors.
                                                                     Page 6 of 18
                                                                                              Estate Planning Split-Dollar (Collateral Assignment)



                                   Economic Benefit Regime: Non-Equity Collateral Assignment
                                                       Non-Contributory


                                                           During The Life Of The Insured


                                                                       Split-Dollar                             Employer
                         Irrevocable Trust                             Arrangement                                (Sponsor)
                    Trustee applies as actual owner and
                                                                                                       Has all rights to policy CV and
                    beneficiary of life insurance policy           Collateral Assignment               is “Treated as Owner” for tax
                           on the Grantor’s life.
                                                                                                                   purposes
                                                                     Life Insurance
                                        Imputed Gift of              Policy
                                                                                                                        Premium
                                        Economic Benefit                                                                Advances


                               Employee
                                (Grantor)                    Imputed Income of
                     Responsible for any income &/or          Economic Benefit
                    gift tax related to economic benefit          Amount




                                                         After The Death Of The Insured


                         Irrevocable Trust                             Split-Dollar
                     Trustee receives the life insurance               Arrangement                              Employer
                         proceeds, in excess of the                                                              (Sponsor)
                      Employer’s share, income and,                                                       Employer receives return of
                        potentially, estate tax free.                                                      advances income tax free.
                                                               Balance of             Return of
                                                                 Death             Sponsor’s Share
                        Distributions                           Benefit          from Death Benefit.



                            Beneficiaries
                      Receive distributions from the                                            Death
                     trustee according to the terms of                                          Benefit
                            the trust agreement.




This is New York Life’s understanding of the generally applicable rules. Please understand New York Life, its agents or employees may not give legal or
                     tax advice. We recommend everyone seek and rely upon the advice of his or her own professional advisors.
                                                                      Page 7 of 18
                                                                                               Estate Planning Split-Dollar (Collateral Assignment)


                                  Economic Benefit Regime: Non-Equity Collateral Assignment
                                                        Contributory


                                                           During The Life Of The Insured

                                                                       Split-Dollar
                                                                       Arrangement                              Employer
                         Irrevocable Trust                                                                       (Sponsor)
                    Trustee applies as actual owner and            Collateral Assignment
                                                                                                     Has all rights to policy CV and is
                    beneficiary of life insurance policy                                               “Treated as Owner” for tax
                                                                 Economic Benefit Payments
                           on the Grantor’s life.                                                                 purposes
                                                                (taxable income to Employer)

                                        Gift of Economic                                                                Premium
                                        Benefit Amount                            Life Insurance                        Advances
                                                                                  Policy

                               Employee
                                (Grantor)
                    Responsible for any gift tax related
                          to economic benefit




                                                         After The Death Of The Insured

                                                                       Split-Dollar
                         Irrevocable Trust                             Arrangement                              Employer
                     Trustee receives the life insurance                                                         (Sponsor)
                     proceeds income and, potentially,                                                    Employer receives return of
                               estate tax free.                                                            advances income tax free.
                                                               Balance of          Return of
                                                              Death Benefit     Sponsor’s Share
                       Distributions                                          from Death Benefit.



                            Beneficiaries
                      Receive distributions from the                                            Death
                     trustee according to the terms of                                          Benefit
                            the trust agreement.




This is New York Life’s understanding of the generally applicable rules. Please understand New York Life, its agents or employees may not give legal or
                     tax advice. We recommend everyone seek and rely upon the advice of his or her own professional advisors.
                                                                      Page 8 of 18
                                                                                              Estate Planning Split-Dollar (Collateral Assignment)


 The Loan Regime                                     loans and the employee’s trust is responsible        compounded annually.53 This would include
                                                     for interest on the loans.                           rates set at zero or any other rate less than the
If a premium payment meets the definition                                                                 blended annual rate.
of “split-dollar loan”, the regulations under        Applicable Loan Rules
the economic benefit regime do not                                                                        The blended annual rate is established by the
apply.42 A premium payment made under                There are different income tax rules applied         IRS and published each July in an IRS
a split-dollar life insurance arrangement is         to arrangements under the loan regime,               Revenue Ruling.54
treated as a loan if:                                depending on whether the loan is a below
                                                     market loan or not and on whether a demand           Employment Context
1. The payment is made by the employer to            loan or a term loan is used. A below-market
   the employee’s trust (including a payment         loan is any demand loan with interest                A below-market demand loan in an
   made to an insurance company on a policy          payable at a rate less than the blended annual       employment context will be treated as if
   held by the trust),43                             rate published by the IRS in July of each            there was a transfer of the forgone interest as
                                                     year,49 and any term loan where the amount           compensation from the lender (employer) to
2. The payment is a loan under general               loaned exceeds the present value of all              the borrower (employee), then retransferred
   principles of Federal tax law, or if it is not,   payments due under the loan.50                       by the borrower to the lender as interest.55
   a reasonable person would expect it to be
   repaid in full,44 and                             The present value calculation for term loans         The amount treated as compensation will be
                                                     is accomplished using the Applicable                 deductible to the employer and included in
3. The repayment is to be made from, or is           Federal Rate (AFR) appropriate to the term           the income of the employee.             The
   secured by, the policy’s death benefit            length. The IRS publishes the AFR each               retransferred interest payment is non-
   proceeds, cash surrender value, or both.45        month.                                               deductible to the employee56 and will be
                                                                                                          treated as taxable income to the employer.
The employee’s trust is treated as the               A split-dollar loan with adequate stated             Thus, the imputed deductible compensation
borrower and the employer is treated as              interest is not a below-market loan and is           to the employer and the imputed taxable
the lender. This is what has been called             governed by the general rules for debt               income to the employer will result in a tax
the “loan regime” of split-dollar taxation.          instruments (including the rules for original        neutral transfer and retransfer for the
                                                     issue discount (OID).51                              employer, but will cause a net tax burden to
Specifically excluded from this definition                                                                the employee.
and placed under the economic benefit                If a split-dollar loan is a below-market loan,
regime already discussed46 are arrangements:         it is governed by IRC § 7872 and the related         Private Split-Dollar Context
  entered into in an employment context              regulations as discussed below. Note that
  where the employer is (or is “treated as”)         tax issues discussed here are income tax             A below-market demand loan in a private
  the owner of the policy,47 or                      unless specifically identified otherwise.            split-dollar context will be treated as if there
  entered into by a donor and donee (private                                                              was a transfer of the forgone interest as a gift
  split-dollar) where the donor is (or is            Below-Market Demand Loans                            from the lender to the borrower, then
  “treated as”) the owner of the policy.48                                                                retransferred by the borrower to the lender as
                                                                                                          interest.
                                                     A demand loan is any loan that is payable in
The result is that in an equity collateral           full at any time, on the demand of the
assignment arrangement, the premium                  lender.52 The code also includes in this             The amount treated as a gift by the lender to
advances from the employer are treated as            definition loans where the interest                  the borrower will be subject to the gift tax
                                                     arrangements are non-transferable and                laws, depending on the facts of the situation.
42                                                   conditioned on the future performance of             It may be that the imputed gift will be treated
   Treas. Reg. § 1.61-22(b)(3).                                                                           as an annual exclusion gift or as a taxable
43
   Treas. Reg. § 1.7872-15(a)(2)(i)(A).
                                                     substantial services, or any loan with an
44                                                   indefinite maturity date.                            gift.
   Treas. Reg. § 1.7872-15(a)(2)(i)(B).
45
   Treas. Reg. § 1.7872-15(a)(2)(i)(C).                                                                   The amount received by the borrower should
46
   Treas. Reg. § 1.61-22(b)(3)(ii).                  A demand loan is considered a below-market
47                                                   loan if the interest payable is set at a rate less   be received with no income tax implications,
    Treas. Reg. § 1.61-22(b)(3)(ii)(A). This                                                              so long as it is considered a gift.
would be non-equity endorsement and non-             than the blended annual rate for the year,
equity collateral assignment arrangements                                                                 53
where the employee or employee’s trust                                                                       Treas. Reg. § 1.7872-15(e)(3)(ii).
                                                                                                          54
receives only the economic benefit of life                                                                    Current and historical revenue rulings
                                                     49
insurance protection.                                   Treas. Reg. § 7872-15(e)(3)(ii).                  publishing applicable federal rates can be found
                                                     50
48
   Treas. Reg. § 1.61-22(b)(3)(ii)(B). Again,           I.R.C. § 7872(e)(1)                               on the IRS web site at:
                                                     51
this could be either a non-equity endorsement           Treas. Reg. § 1.7872-15(a)(1). OID rules are      http://www.irs.gov/taxpros/lists/0,,id=98042,00
or     non-equity      collateral    assignment      under § 1271 through 1275 of the Internal            .html
                                                                                                          55
arrangement where the donee receives only the        Revenue Code.                                           IRC § 7872(a)(1).
                                                     52                                                   56
economic benefit of life insurance protection.          IRC § 7872(f)(5).                                    Treas. Reg. § 1.7872-15(c).

This is New York Life’s understanding of the generally applicable rules. Please understand New York Life, its agents or employees may not give legal or
                     tax advice. We recommend everyone seek and rely upon the advice of his or her own professional advisors.
                                                                      Page 9 of 18
                                                                                                Estate Planning Split-Dollar (Collateral Assignment)


The amount considered retransmitted from           borrower and will be received as taxable                   The excess of the amount loaned over the
the borrower to the lender as interest will be     income to the lender.                                      present value of the payments due will be
non-deductible to the borrower57 and treated                                                                  considered Original Issue Discount (OID)65
as taxable income to the lender.                   Below-Market Term Loans                                    and will be included in the gross income of
                                                                                                              the borrower.66
Corporation/Shareholder Context                    A term loan is any loan that is not a demand
                                                   loan.61 The term of the loan can be defined                To illustrate this, consider a 5-year term loan
A below-market demand loan in a                    by:                                                        of $50,000. If the current mid-term AFR is
corporation/shareholder context will be                                                                       4% and the amount to be repaid in 5 years is
treated as if there was a transfer of the          1. a stated maturity date,                                 $55,000, then the calculated present value of
forgone interest as a dividend from the                                                                       that repayment using the 4% AFR discount
lender (corporation) to the borrower               2. a period ending no later than the death of              rate is $45,119.67 The excess of the amount
(shareholder), then retransferred by the              an individual,                                          loaned over the present value of the
borrower to the lender as interest.                                                                           repayment due is $4,881. This total amount
                                                   3. the earlier of the death of an individual or            will be considered OID and included in the
The amount treated as a dividend will be              a specified term,                                       gross income of the borrower in the year of
taxed to the corporation according to its                                                                     the loan. Another way to look at it is that the
status and to the shareholder according to         4. the later of the death of an individual or a            $45,119 amount is all that should have been
various factors:                                      specified term,                                         loaned at the 4% AFR if all that is to be paid
                                                                                                              back is $55,000. The “extra” amount loaned
A C-Corp will have been taxed on its income                                                                   is considered taxable income.
                                                   5. a condition of future performance of
at the corporate level, the dividend will not         services, or
be deductible to the corporation, and the                                                                     Note that the income tax implications of a
dividend will be included in the income of                                                                    below-market term loan with a stated
                                                   6. the later of a term certain or the date
the borrower as a taxable dividend.                                                                           maturity date will be realized in the year that
                                                      when a condition of future performance
                                                                                                              the loan is taken and not spread out over the
                                                      ends.
An S-Corp will have had its income taxed                                                                      life of the loan as you could expect with a
under the flow-thru rules of subchapter S58                                                                   demand loan. This is one of the “costs” of
                                                   Each of these types of term loans is
and the dividend will likely be received by                                                                   establishing the terms of the loan for a set
                                                   discussed below with examples to illustrate
the shareholder as a tax-free return of basis,                                                                period of time.
                                                   each. Term loans can be made in an
assuming no other tax issues have already          employment context, corporate shareholder
reduced the shareholder’s basis.                                                                              Loans Payable Not Later Than the
                                                   context, or a private split-dollar context.
                                                                                                              Death of an Individual, or at the Earlier
The amount considered retransmitted from                                                                      of Death of an Individual or a Specified
                                                   Loans with a Stated Maturity Date
the borrower (shareholder) to the lender                                                                      Term
(corporation) as interest will be non-             A term loan with a stated maturity date is
deductible to the borrower59 and as taxable        considered a below-market loan if the
                                                                                                              A split-dollar loan that is payable not later
income to the lender.                                                                                         than the death of an individual is considered
                                                   amount loaned exceeds the present value of
                                                                                                              a term loan for purposes of determining
                                                   all payments due under the loan, calculated
Timing of imputed interest transfers                                                                          whether the loan provides for sufficient
                                                   using a discount rate equal to the applicable
                                                                                                              interest.68
                                                   Federal rate,62 compounded semiannually.63
Regardless of the context, the imputed             The applicable Federal rate is established by
transfers of interest under a below-market                                                                    If the loan is payable at the death of an
                                                   IRC § 1274(d). This rate is updated and
demand loan will be treated as if they had                                                                    individual, the term of the loan is the life
                                                   published each month in an IRS Revenue
occurred on the last day of the calendar year,                                                                expectancy of the individual as determined
                                                   Ruling.64
unless the regulations provide otherwise.60                                                                   under the appropriate table in Treas. Reg. §
                                                                                                              1.72-969 on the day the loan is made.
                                                   The appropriate rate is determined by the
Actual Interest Payments                           term of the loan:
                                                   Term                                             AFR
Any interest that is actually paid by the          Not over 3 years............................ Short-Term    65
borrower will not be deductible to the             Over 3 years – not over 9 years...... Mid-Term                IRC § 7872(b)(2).
                                                                                                              66
                                                   Over 9 years.................................. Long-Term      IRC § 1272(a)(1).
                                                                                                              67
                                                                                                                  Remember that the calculation is based on
                                                                                                              semi-annual compounding.
57                                                 61
   Treas. Reg. § 1.7872-15(c).                        IRC § 7872(f)(6).                                       68
                                                                                                                  Treas. Reg. §§ 1.7872-15(e)(4)(iii)(D) and
58                                                 62
   IRC §§ 1361 - 1379.                                IRC § 7872(e)(1)(B).                                    1.7872(e)(5)(i).
59                                                 63                                                         69
   Treas. Reg. § 1.7872-15(c).                        IRC § 7872(f)(2)(A).                                       A pdf version of this regulation is currently
60                                                 64
   IRC § 7872(a)(2).                                  See note 47 above.                                      available at:

This is New York Life’s understanding of the generally applicable rules. Please understand New York Life, its agents or employees may not give legal or
                     tax advice. We recommend everyone seek and rely upon the advice of his or her own professional advisors.
                                                                     Page 10 of 18
                                                                                           Estate Planning Split-Dollar (Collateral Assignment)


If the loan is payable on the earlier of an        the shorter of the insured’s life expectancy or      maturity date described above, using the
individual’s death or another specified term,      10 years. Using Table V under Treasury               specified term and AFR used for the testing.
the term of the loan is the shorter of the term    Regulation § 1.72-9, the life expectancy of
provided in the loan, or the individual’s life     an 81 year old is 8.9 years, thus the term of        To illustrate this, assume the same facts as
expectancy as determined under the                 the loan is 8.9 years and the federal mid-term       the example above under “Loans with Stated
appropriate table in Treas. Reg. § 1.72-9 on       rate applies.74 The present value of the total       Maturity”:
the day the loan is made.70 This allows the        to be repaid is $44,409.75 Since the loaned            5-year term loan of $50,000,
possibility that a term loan for 10 years, as an   amount of $50,000 exceeds this, the loan is            mid-term AFR is 4%,
example, may be treated under the federal          considered a below market loan.                        amount to be repaid is $55,000,
mid-term or short-term rate rather than the                                                               but assume that the individual is only 60
long-term rate if the individual’s life            Next, determine the imputed interest of the            years old, with a life expectancy of 24
expectancy is 9 years or less.                     below market loan. This type of loan is                years, and the long-term AFR is 5%.
                                                   treated as a demand loan except that the
The loan is tested under the same test as is       appropriate AFR is used rather than the              The term to be used is the 5-year stated term,
used on a term loan with a stated maturity as      blended annual rate, so, the mid-term rate of        but the interest rate will be the long-term
discussed above.                                   3.6% of this example applies and we ignore           rate.
                                                   the 3% blended rate. The imputed interest is
If the loan provides for sufficient interest, it   calculated for each year the loan is                 The calculated present value of that
will be subject to the same Internal Revenue       outstanding and is the excess of the interest        repayment is $42,966.78 The excess of the
Code and regulatory provisions for stated          calculated using the AFR over the interest           amount loaned over the present value of the
interest and OID as other loans.71                 under the terms of the loan. With a starting         repayment due is $7,034. This total amount
                                                   balance of $50,000 and a 3.6% AFR, the               will be considered OID and included in the
If the loan does not provide for sufficient        calculated first-year interest would be $1800        gross income of the borrower in the year of
interest, IRC § 7872 applies and the loan will     (using annual compounding). The interest             the loan.
be treated as a below market demand loan,72        provided in the loan at 2% would be $1000.
but imputed interest will be calculated each       This produces an imputed first-year interest         Loans Payable on Condition of Future
year using the appropriate term AFR rather         of $800 that would be treated as transferred         Performance of Substantial Services
than the blended annual rate used by               from the lender to the borrower and then
“regular” demand loans.                            retransferred to the lender.         See the         If split-dollar loan benefits are not
                                                   discussion under Below Market Demand                 transferable and are conditioned on the
The imputed interest is the excess of the          Loans above for the tax implications of these        future performance of substantial services,79
calculated amount using the appropriate            imputed interest transfers.                          it is tested as discussed above as a term loan
AFR for the established term over the                                                                   using the stated term if there is one, or an
amount that accrues or is paid under the           Loans Payable at the Later of the Death              assumed term of 7 years.80
terms of the loan.                                 of an Individual or a Specified Term
                                                                                                        If the loan provides for sufficient interest, it
To illustrate this, consider a 10-year term        A term loan with a term defined as the later         will be subject to the same Internal Revenue
loan of $50,000, that is payable at the            of the death of an individual or a specified         Code and regulatory provisions for stated
insured’s death if it occurs before the term of    term will be tested for adequate stated              interest and OID as other loans.81
the loan. Assume further that the insured is       interest under the same rules that apply to
81 years old, there is stated annual interest of   loans with a stated maturity date, using the         If the loan does not provide for sufficient
2%, with a total amount to be repaid of            specified term, ignoring the life expectancy         interest, it is treated as a below-market
$61,01073 and the current AFRs are mid-            of the individual.76 In contrast, the longer of
term = 3.6%, long-term = 4.8%, and the             the specified term or the life expectancy of
blended annual rate is 3.0%.                       the individual determines the applicable             78
                                                                                                           Remember that the calculation is based on
                                                   AFR.77 If the loan is a below-market term            semi-annual compounding.
                                                                                                        79
First, determine if the term loan provides for     loan, the foregone interest will be calculated          See IRC § 83 and Treas. Reg. § 1.83-3 for
sufficient interest. The present value of the      the same as a term loan with a stated                more on “future performance of substantial
total amount to be repaid is calculated using                                                           services.”
                                                                                                        80
                                                                                                           Treas. Reg. § 1.7872-15(e)(5)(iii)(C). But if
                                                   74
                                                                                                        the loan remains outstanding longer than the
http://a257.g.akamaitech.net/7/257/2422               The individual’s life expectancy controls so      assumed term, it will be considered retired and
/12feb20041500/edocket.access.gpo.gov/             the long-term rate of the 10 year term cannot be     re-issued at the assumed maturity, and tested
cfr_2004/aprqtr/pdf/26cfr1.72-9.pdf                used.                                                again for sufficient interest.
70                                                 75
   Treas. Reg. § 1.7872-15(e)(5)(ii)(C).              Remember, semi-annual compounding, so,            81
                                                                                                            Treas. Reg. §§ 1.7872-15(e)(5)(iii)(B) &
71
   Treas. Reg. § 1.7872-15(f).                     17.8 periods at 1.8% with a future value of          1.7872-15(f) (note exception that § 1.1272-
72
   Treas. Reg. § 1.7872-15(e)(5)(ii)(B).           $61,010.                                             1(c), dealing with debt instruments subject to
73                                                 76
   Calculated with interest accrued on a semi-        Treas. Reg. § 1.7872-15(e)(5)(v)(B)(2).           contingencies, does not apply to any split-dollar
                                                   77
annual basis.                                         Treas. Reg. § 1.7872-15(e)(5)(v)(B)(3).           loan).

This is New York Life’s understanding of the generally applicable rules. Please understand New York Life, its agents or employees may not give legal or
                     tax advice. We recommend everyone seek and rely upon the advice of his or her own professional advisors.
                                                                   Page 11 of 18
                                                                                            Estate Planning Split-Dollar (Collateral Assignment)


demand loan, with the imputed interest              The term of the loan used to determine the          Termination of Arrangement
determined each year that the loan is               AFR depends upon the details of the                 During Insured’s Life
outstanding using the current AFR                   arrangement. See the appropriate paragraph
appropriate for the term as was shown in the        above for gift loans with a term defined by:
                                                                                                        Rather than maintaining a split-dollar
preceding example.82                                   a stated maturity date,
                                                                                                        arrangement until payment of the death
                                                       a period ending no later than the death of
                                                                                                        benefit, the arrangement can be terminated
Loans Payable Upon the Later of a                      an individual,
                                                                                                        by agreement of the parties during the life of
Term Certain and the end of a Condition                the earlier of the death of an individual or
                                                                                                        the insured. The tax ramifications of a
of Future Performance                                  a specified term, or
                                                                                                        termination at this time will be dependent on
                                                       the later of the death of an individual or a
                                                                                                        the relationship of the parties, and how the
If a split-dollar loan is payable upon the later       specified term.
                                                                                                        obligations under the arrangement are met.
of a term certain or the date on which a
condition to perform substantial future             As a gift loan, there are also gift tax issues to
                                                                                                        In an employment relationship, the borrower
services ends, the loan will be treated as a        consider. For purposes of the gift tax rules,
                                                                                                        (the employee or employee’s trust) has a
split-dollar term loan with stated maturity as      the loan will be considered a term loan.86
                                                                                                        loan balance that must be satisfied. This can
discussed above, and the term of the loan           This will cause the present value of the
                                                                                                        be accomplished by:
will be the term certain.83                         imputed gift to be considered in the year that
                                                                                                           payment of the outstanding loan balance to
                                                    the loan is established.
                                                                                                           the lender,
The appropriate AFR will be either the mid-                                                                forgiveness of the outstanding loan
term or the long-term rate, determined by the       Imputed Interest Taxation                              balance by the lender, or
longer of the term certain or seven years.                                                                 partial payment and partial forgiveness of
                                                    Regardless of the type of term loan, any               the remaining balance.
Gift (Private Split-dollar) Term Loans              unpaid interest that is imputed will have tax
                                                    consequences.                                       Payment of the loan balance by the borrower
A gift term loan can arise under a private                                                              can be accomplished using funds available
split-dollar arrangement. It is tested for          If the arrangement is made in an                    from the policy cash values or funds
sufficient interest the same way a non-gift         employment or shareholder context, the              available from other sources. Funds from
split-dollar term loan is tested, as discussed      imputed interest will be included in the            the policy will carry the tax attributes any
above under “Loans with a Stated Maturity           borrower’s gross income.87                          other policy withdrawal or loan would carry.
Date”.                                                                                                  Funds from another source would carry their
                                                    Death Benefit Taxation                              own unique tax attributes, if any. Regardless
If the loan provides for sufficient interest, it                                                        of the source of funds, the repayment of the
will be subject to the same Code and                Generally, death benefit payments received          loan is not tax deductible to the borrower91
regulatory provisions for stated interest and       by the beneficiary of a life insurance contract     and, to the extent funds were loaned, the
OID as other loans.84                               subject to a split-dollar arrangement will not      repayment will be received by the lender as a
                                                    be included in the beneficiary’s income.88          tax-free repayment of the loan principal. To
If the loan does not provide for sufficient                                                             the extent that accrued interest on the loan is
interest, the regulations provide a special rule    Any amount received by a lender under a life        paid, the lender will have taxable income.
for gift (private split-dollar) term loans          insurance contract that is part of a split-dollar
where the imputed interest is determined            life insurance arrangement is treated as            If the lender forgives some or all of the loan
annually under the rules for a below-market         though the amount had been paid to the              principal, that amount will be treated as
demand loan,85 but the interest rate will be        borrower, and then paid by the borrower to          having been transferred from the lender to
the AFR appropriate to the loan’s term rather       the lender.89 To the extent that split-dollar       the borrower and then retransferred to the
than the blended rate used for regular              loans had been made by the lender to the            lender as payment. The amount treated as
demand loans.                                       borrower, the amount paid to the lender             transferred to the borrower (employee) will
                                                    should be received as payment of any                be characterized as taxable compensation.
82
   Treas. Reg. § 1.7872-15(e)(5)(iii)(B).           accrued interest and then a tax-free
83
   Treas. Reg. § 1.7872-15(e)(5)(v)(B). But if      repayment of the loan.90                            Accrued and Forgiven Interest
the loan remains outstanding longer than the
term certain, it will be considered retired and                                                         If interest is accrued and subsequently
re-issued at maturity, but not tested again for                                                         waived, cancelled, or forgiven, it is treated as
sufficient interest.                                86                                                  if, on that date, the interest had been paid to
84
    Treas. Reg. §§ 1.7872-15(e)(5(iv)(B) &             Treas. Reg. § 1.7872-15(e)(5)(iv)(D).
                                                    87                                                  the lender and then retransferred by the
1.7872-15(f) (note exception that § 1.1272-            Treas. Reg. § 1.7872-15(e)(1)(i) & IRC § 61.
                                                    88                                                  lender to the borrower. Additionally, the
1(c), dealing with debt instruments subject to          Treas. Reg. § 1.7872-15(m) and IRC §
contingencies, does not apply to any split-dollar   101(a).
                                                    89                                                  91
loan).                                                 Treas. Reg. § 1.7872-15(m).                        Treas. Reg. § 1.7872-15(c), IRC §§ 163(h)
85                                                  90
   Treas. Reg. § 1.7872-15(e)(5)(iv)(B).               Treas. Reg. § 1.7872-15(k).                      and 264(a).

This is New York Life’s understanding of the generally applicable rules. Please understand New York Life, its agents or employees may not give legal or
                     tax advice. We recommend everyone seek and rely upon the advice of his or her own professional advisors.
                                                                    Page 12 of 18
                                                                                           Estate Planning Split-Dollar (Collateral Assignment)


amount treated as retransferred to the
borrower will be increased by a “deferral
charge” .92

The regulation under § 7872 provides a
default deferral charge to be used until such
time as the Commissioner of the IRS
establishes the final charge. The default
deferral charge in the regulation depends on
whether the loan is treated as a term loan or a
demand loan, and is determined by use of the
applicable underpayment rate or the highest
income tax applicable to the borrower.93

To aid in understanding a collateral
assignment arrangement taxed under the loan
regime, the basic arrangement is shown in
diagrams below, showing arrangements
where the policy is owned by an employee’s
irrevocable trust. Two diagrams are shown
to help distinguish between a loan where
interest is accrued and a loan where interest
is paid.

The diagrams assume the arrangement stays
in place until the death of the insured (no
roll-out) and policy death proceeds are used
to pay the employer. The employer is also
assumed to be a cash basis taxpayer and is
actually paid the accrued interest.




92
     Treas. Reg. § 1.7872-15(h)(1)(i).
93
     Treas. Reg. § 1.7872-15(h)(4).

This is New York Life’s understanding of the generally applicable rules. Please understand New York Life, its agents or employees may not give legal or
                     tax advice. We recommend everyone seek and rely upon the advice of his or her own professional advisors.
                                                                   Page 13 of 18
                                                                                           Estate Planning Split-Dollar (Collateral Assignment)



                                                  Loan Regime: Equity Collateral Assignment
                                                              Interest Accrued


                                                            During The Life of The Insured

                                                                       Split-Dollar
                          Irrevocable Trust                            Arrangement
                                                                                                                 Employer
                                                                       Collateral Assignment                       (Sponsor)
                        Trustee applies as owner and
                     beneficiary for life insurance on the                                                interest charges are accrued.
                                Grantor’s life.

                                                                                                                          Premium
                                                                                   Life Insurance                          Loans
                                                                                   Policy

                                Employee
                                 (Grantor)




                                                             After Death of The Insured

                                                                       Split-Dollar
                          Irrevocable Trust                                                                      Employer
                                                                       Arrangement
                                                                                                                   (Sponsor)
                      Trustee receives the life insurance
                       proceeds income and estate tax                                                    Accrued interest is received as
                                     free.                                                                     taxable income.
                                                                Balance of          Return of
                                                               Death Benefit     Sponsor’s Share
                         Distributions                                         from Death Benefit
                                                                               (including accrued
                                                                                    interest).
                              Beneficiaries
                        Receive distributions from the                                         Death
                       trustee according to the terms of                                       Benefit
                              the trust agreement.




This is New York Life’s understanding of the generally applicable rules. Please understand New York Life, its agents or employees may not give legal or
                     tax advice. We recommend everyone seek and rely upon the advice of his or her own professional advisors.
                                                                     Page 14 of 18
                                                                                             Estate Planning Split-Dollar (Collateral Assignment)


                                                 Loan Regime:Equity Collateral Assignment
                                                              Interest Paid


                                                          During The Life of The Insured

                                                                      Split-Dollar
                         Irrevocable Trust                            Arrangement
                                                                                                              Employer
                                                                     Collateral Assignment                      (Sponsor)
                       Trustee applies as owner and
                    beneficiary for life insurance on the            Interest Payments              Interest received as taxable income
                               Grantor’s life.

                                         Gift of loan interest                                                         Premium
                                                                                 Life Insurance                         Loans
                                                                                 Policy
                               Employee
                                (Grantor)




                                                             At Death of The Insured

                                                                     Split-Dollar
                        Irrevocable Trust                                                                    Employer
                                                                     Arrangement
                    Trustee receives the life insurance                                                        (Sponsor)
                     proceeds income and estate tax
                                   free.                      Balance of      Return of
                                                             Death Benefit    Sponsor’s Share
                       Distributions                                          from Death Benefit.


                            Beneficiaries
                                                                                             Death
                      Receive distributions from the
                                                                                             Benefit
                     trustee according to the terms of
                            the trust agreement.




This is New York Life’s understanding of the generally applicable rules. Please understand New York Life, its agents or employees may not give legal or
                     tax advice. We recommend everyone seek and rely upon the advice of his or her own professional advisors.
                                                                     Page 15 of 18
                                                                                           Estate Planning Split-Dollar (Collateral Assignment)


Choice of Regimes                                  Alternatively, if the parties’ overriding            minimizing costs and a secondary goal of
                                                   objective is to minimize annual out-of-              building cash value in the policy for future
Economic considerations, both business             pocket costs, the parties might not change           needs.     Under the economic benefit
and personal, will often be the drivers            to the loan regime until some time after             regime, policy cash values are available
behind the design of a split-dollar                gain has been attained, accepting the tax            only to the employer. Changing the
arrangement. Choices made in the design            consequences associated with making the              arrangement so that the employee or
process will determine which of the two            change with gain in the cash value.                  employee’s trust can access policy cash
taxing regimes will        control the                                                                  values in the future will cause the
arrangement.                                       Many approaches to the balancing of the              arrangement to be taxed under the loan
                                                   cost considerations are possible.                    regime.95 At the time this change takes
The loan regime would apply to any                                                                      place, the policy is treated as having been
arrangement providing the insured or the           Reasons to Change Regimes                            transferred from the employer to the
insured’s trust with access to policy cash                                                              employee or the employee’s trust, and any
values, but the economic benefit regime            The economics behind a decision to                   fair market value96 in excess of the
may result in lower out-of-pocket costs to         change taxing regimes may be driven by               premiums advanced by the employer (gain
the insured, at least initially.                   annual cost, income tax, or business                 in the cash value) up to that time will be
                                                   considerations.    In many cases, a                  subject to income taxation to the
Business considerations of the employer            combination of these will influence the              employer.
may drive the type and amount of benefit           final decision.
to be provided, affecting the choice of                                                                 Avoiding potential income tax costs when
regimes.                                           Annual Cost Considerations                           changing regimes will require a change at
                                                                                                        a point in time before the fair market value
Often, an estate planning split-dollar             A split-dollar arrangement that is taxed             exceeds the total premiums advanced by
arrangement will be entered under the              under the economic benefit regime will               the employer. This point in time can be
economic benefit regime so as to take              experience annually increasing economic              referred to as the equity crossover. It is
advantage of the initially lower out of            benefit costs as the insured ages. It is             possible that the equity crossover might
pocket costs or gifts to a trust possible to       possible that the economic benefit costs             occur before the costs crossover. Thus,
many clients under the current life                will eventually increase to the point that           changing regimes at a time calculated to
insurance premium factor provided by the           the then-current interest rate could produce         avoid an income tax event can result in an
IRS.94 Of course, the specific facts of a          a lower cost under the loan regime.                  increase in annual costs, at least for some
case may produce a different result, e.g.,                                                              period of time. Generally, a compromise
the higher economic benefit costs of an            A split-dollar arrangement with a                    must be reached between the two sets of
older insured, and/or the lower costs              survivorship policy has relatively low               considerations, unless there is another,
possible during a time of very low interest        economic benefit costs during the lives of           possibly overriding factor.
rates may cause the loan regime to be              both insureds, making the economic
more attractive from the start.                    benefit regime a very attractive starting            Business Considerations
                                                   point. At the death of the first insured to
                                                                                                        In addition to estate planning needs, a
Switching Regimes                                  die, the economic benefit costs increase
                                                   significantly, possibly causing the                  collateral assignment split-dollar arrange-
                                                   economic benefit regime costs to exceed              ment may be entered under the economic
Economic considerations may cause an
                                                   loan regime costs.                                   benefit regime so that the employer will
insured to enter into a split-dollar
                                                                                                        initially have access to the policy cash
arrangement under the economic benefit
                                                   The point in time that the annual economic           values.     This business need may be
regime, but, as time passes, those same
                                                   benefit costs would drive a change in                specific enough that a certain year can be
considerations may also create pressures to
                                                   regime can be referred to as the cost                identified when that need ends. This kind
change the terms of the split-dollar
                                                   crossover. If the annual cost of the                 of business consideration may make it
agreement which would cause the taxation
                                                   arrangement       is     the     controlling         appropriate to change to the loan regime at
of the arrangement to be switched to the
                                                   consideration, changing to the loan regime           the end of that year so that the insured can
loan regime. The exact year of the change
                                                   at the cost crossover might make economic            access cash values thereafter.          This
can be driven by different considerations.
                                                   sense. Yet, as important as annual cost              business requirement may also be
                                                   considerations are, they are rarely the only         balanced with, or even override
For example, to avoid taxation of gain of                                                               considerations of the cost and equity
policy cash value, the parties would need          consideration.
                                                                                                        crossovers.
to change to the loan regime before the
policy develops gain.                              Income Tax Considerations
                                                                                                        95
                                                   An insured may enter a split-dollar                    Treas. Reg. § 1.61-22(c)(1)(ii)(B).
                                                                                                        96
                                                   arrangement with an initial goal of                    Treas. Reg. § 1.61-22(g), and see Rev. Proc.
94
     Table 2001.                                                                                        2005-25

This is New York Life’s understanding of the generally applicable rules. Please understand New York Life, its agents or employees may not give legal or
                     tax advice. We recommend everyone seek and rely upon the advice of his or her own professional advisors.
                                                                   Page 16 of 18
                                                                                           Estate Planning Split-Dollar (Collateral Assignment)


Monitoring and Review                              the subject of a non-equity collateral               protection to the employee or employee’s
                                                   assignment split dollar arrangement may              trust. The employer holds all rights to
Split-dollar arrangements are dynamic, not         not be the actual owner of the policy, so            policy values other than the death benefit
static. Initial illustrations and projections      changing “owner” does not necessarily                protection going to the employee or
cannot be relied upon in later years.              involve an actual transfer of the policy.            employee’s trust. Another way to phrase
                                                                                                        this is that the employer has the right to be
The current life insurance premium factor          A new split-dollar arrangement will be               repaid the greater of the total of premiums
provided by the Internal Revenue Service           required, stating the parties’ new rights            advanced or the policy fair market value.
for computing economic benefit costs are           and obligations, changing from a non-
subject to possible future guidance.97             equity arrangement to an equity                      If the policy fair market value is greater
Since this premium factor may change,              arrangement. When changing to an equity              than the total of the premiums advanced,
projections related to cost crossovers can’t       arrangement to be taxed under the loan               the starting loan balance under a switch to
be relied upon to establish future costs or        regime, a note instrument should also be             the loan regime will be the policy fair
when a regime change should occur.                 put in place. The parties’ legal and tax             market value.
                                                   advisors should be consulted for the
The economic benefit costs of a                    drafting of these new documents.                     If the policy fair market value is less than
survivorship policy will be significantly                                                               the total of the premiums advanced, the
affected by the death of the first insured to      Tax Implications at the Change                       starting loan balance will be the total of
die. This first death will be an unpredict-                                                             the premiums advanced.
able event that may drive a decision to            Regardless of the process or the driving
change regimes.                                    factors behind the decision to change                Split-Dollar Arrangements &
                                                   regimes, the change will occur before, at,           ERISA
The cash value of a life insurance policy          or after the equity crossover.
will grow based on prevailing rates. Since                                                              Generally,     split-dollar   arrangements
this is subject to change driven by market         If the fair market value of the policy is less       established by employers to provide death
conditions, projections related to cash            than or equal to the total premiums                  benefits for their executives’ beneficiaries
value won’t remain valid over time.                advanced by the employer, a change that              are welfare benefit plans under the
                                                   provides the employee or employee’s trust            Employee Retirement Income Security Act
Regardless of the considerations that will         access to the cash value will not be a               of 1974 (ERISA) and therefore, subject to
drive an insured’s ultimate decision as to a       taxable event. At that point in time, the            Title I of ERISA.99 Welfare benefit plans
change of regime, it is important to               obligation to the employer will be at least          are exempt from ERISA participation,
recognize that at the time a split-dollar          equal, if not greater than the cash value,           funding and vesting requirements,
arrangement is established, it will                thus leaving no excess cash value available          however they are subject to ERISA
generally not be possible to know in               to the employee or employee’s trust.                 fiduciary, claims, reporting and disclosure
advance the exact point in time when the                                                                and prohibited transaction requirements
change should occur, or even whether it            If the fair market value of the policy               and rules.
should occur at all. Regular and consistent        exceeds the total premiums advanced by
monitoring      and     review      of   the       the employer, a change that provides the             A split-dollar arrangement that is
arrangement’s goals and economics, from            employee or employee’s trust access to the           unfunded or insured and maintained
each party’s perspective, are necessary to         cash value will be a taxable event. At that          primarily for a group of select
assure the desired results are attained.           point in time, the employee or employee’s            management or highly compensated
                                                   trust will accept a note obligation (loan            employees is exempt from the full ERISA
Mechanics of Making the Change                     regime) for the fair market value of the             reporting and disclosure requirements.100
                                                   policy at the time of the change. This loan          There is no requirement to file any notice
Once it has been determined that a change          is not taxable to the employee or                    with the Department of Labor with regards
of taxing regime should occur, the change          employee’s trust. At the time of the                 to such arrangements. The phrase “select
can generally be accomplished by a                 change, the employer will also be                    group of management or highly
change in the arrangement that will switch         considered to have made a complete                   compensated employees” has not been
the “owner” for tax purposes from one              transfer of the policy, triggering                   defined, and there is vagueness in the
party to the other.98                              recognition of any gain in the policy to the         terms “unfunded or insured.” Department
                                                   employer.                                            of Labor Advisory Opinions imply only
Remember,       under    the    split-dollar                                                            that this select group generally consists of
regulations, the “owner” of a policy that is       Starting Balance of Loan Regime                      an employer’s highest paid key employees
                                                                                                        or management.
                                                   A collateral assignment split-dollar
97
   Treas. Reg. 1.61-22(d)(3)(ii).                  arrangement taxed under the economic
98                                                                                                      99
    Treas. Reg. §§ 1.61-22(c)(1)(ii)(B)(2) &       benefit regime provides only life insurance               DOL Advisory Opinion 77-2.
                                                                                                        100
(b)(3).                                                                                                      DOL Reg. §2520.104-24.

This is New York Life’s understanding of the generally applicable rules. Please understand New York Life, its agents or employees may not give legal or
                     tax advice. We recommend everyone seek and rely upon the advice of his or her own professional advisors.
                                                                   Page 17 of 18
                                                                                           Estate Planning Split-Dollar (Collateral Assignment)


Summary
Collateral assignment split-dollar arrange-
ments “entered into” after September 17,
2003 will be taxed under either Treasury
Regulation § 1.61-22 (economic benefit
regime) or § 1.7872-15 (loan regime).

A collateral assignment split-dollar
arrangement structured as a non-equity
arrangement will generally be taxed under
the economic benefit regime.

A collateral assignment split-dollar
arrangement structured as an equity
arrangement will generally be taxed under
the loan regime.

Various considerations may make it
attractive for an arrangement to be initially
structured as non-equity and then later
changed to an equity arrangement so as to
cause the taxing regime to be changed
from economic benefit taxation to loan
taxation. The tax ramifications of this
change will vary over time, depending on
the policy fair market value as compared
to the total premiums advanced by the
employer.       Regular monitoring of all
relevant values under the arrangement are
key to making appropriate decisions over
the life of a split-dollar arrangement.




                                                                                                          New York Life Insurance Company

                                                                                                          New York Life Insurance and Annuity
                                                                                                          Corporation (A Delaware Corporation)

                                                                                                          51 Madison Avenue
                                                                                                          New York, NY 10010

                                                                                                          www.newyorklife.com

                                                                                                          The Company You Keep®




This is New York Life’s understanding of the generally applicable rules. Please understand New York Life, its agents or employees may not give legal or
                     tax advice. We recommend everyone seek and rely upon the advice of his or her own professional advisors.
                                                                   Page 18 of 18

								
To top