Split-Dollar Redux: CPAs May Find the Benefits a Thing of the Past

The tax treatment of split-dollar insurance plans continues to evolve. Previously, companies used split-dollar life insurance to help employees defer taxation on the yearly accumulation of the policy's cash surrender value as well as to provide a significant death benefit. Then, in revenue notice 2001-10 the IRS said any enrichment employers give employees using split-dollar insurance plans generally is taxable. Now, the IRS has issued revenue notices 2002-8 and 2002-59, as well as proposed regulations, which together make many of the benefits of split-dollar a thing of the past. Here's how the changes affect clients with split-dollar insurance plans and what CPAs can do about them. INTERIM GUIDANCE Notice 2002-8 offers guidelines to employers and employees until the IRS issues final split-dollar regulations; the rules make two critical points about the tax treatment: * IRC sections 1271 to 1275 and 7872 would treat premiums the employer pays as a series of interest-free loans to the employee. * Otherwise, the IRS would consider the economic benefits of the policy (including any share of cash values when an employee receives them) to be transfers to that employee under IRC sections 61 and 83. The employee would value the economic benefit using the appropriate tables and rates explained below. Under notice 2002-8 timing is critical when the employee computes insurance protection values using section 61. The key date for CPAs to remember is January 28, 2002. Plans entered into before this date must use table 2001, which is part of revenue notice 2001-10, to determine the value of life insurance protection the employer provides under the plan. (Table 2001 is the commonly accepted authority for valuing policies. It superseded the old PS 58 rates as of January 1, 2002.) Plans also can use the more favorable insurance company one-year term rates to determine the value of life insurance protection. A plan entered into after January 28, 2002, can use the insurer's published premium rates until January 1, 2004. Thereafter, for an employee to use these rates, the insurer must make them known to all persons who apply for term coverage and must use those rates when selling such coverage. That means the subsequent rates will be higher than those companies now are quoting. Timing also is critical to how the IRS will tax policy cash values transferred to employees. Participants in split-dollar arrangements entered into before January 28, 2002, can terminate or convert such plans to loans by January 1, 2004, with no tax liability to the individual taxpayer under the safe harbor in notice 2002-8. THE END OF REVERSE SPLIT-DOLLAR In notice 2002-59 the IRS specifically targets these plans, where one party buys a policy (usually a family member or employee) and then "rents" the death benefits to another (a wealthier family member or employer). With the rent payments typically greatly exceeding the actual cost of the death benefit the policy provides, this strategy transfers large amounts of cash from one entity or individual to another with little or no tax liability. Notice 2002-59 prohibits reverse split-dollar plans from using either table 2001 or the insurer's alternative premium rates to value current life insurance protection. Since these are the only two authoritative ways of doing so, there is no method a reverse split-dollar plan can use to safely compute a policy's economic value for tax purposes. Because the notice does not offer an alternative, it essentially eliminates reverse split-dollar plans as a means of transferring wealth. The notice similarly provides no apparent remedy for existing reverse split-dollar plans that now are out of compliance with the law. The IRS will likely address the disposition of these plans--one taxpayer at a time. PROPOSED REGS The regulations the Treasury Department published in July 2002 apply to split-dollar policies and have a variety of provisions. …