IRS revising rules for split-dollar insurance.

• Author: Lerman, Jerry L.

On Jan. 10, 2001, the IRS released Notice 2001-10, indicating that it is (1) reviewing the tax treatment of "split-dollar" life insurance arrangements, (2) "clarifying" prior rulings on split-dollar arrangements, (3) providing "interim guidance" and (4) requesting comments. The Service has definitely "fired a shot across the bow" of split-dollar arrangements.

The notice addresses "split-dollar arrangements between employers and employees" but then goes on to state that these principles "govern the Federal tax treatment of split-dollar arrangements in other contexts, including arrangements that provide compensation to non-employees and economic benefits to corporate shareholders and arrangements involving gifts." Additionally, even though this is an initial notice and the Service has requested comments, it provides interim guidance for all split-dollar arrangements. Commentators have already pointed out several ambiguities and issues that the IRS will need to resolve. However, in the meantime, this guidance should not be underestimated or ignored.

Basically, the notice provides a choice of using either a Sec. 7872 below-market-interest loan method or a Sec. 83 compensation method. Either way, the Service is requiring an employer to account for any and all economic benefits conferred on an employee.

The notice describes the tax treatment alternatives available under these two methods:

* Premiums that an employer pays must be structured as bona fide loans subject to Sec. 7872. This creates imputed income for an employee as compensation, but does not create income under Sec. 83 on the cash value shifted to (and not forfeitable) by the employee. Simply put, the employee would not recognize as annual income the economic benefit of the Table 2001 annual term rates. An inherent danger occurs when the employee does not repay the loan under its terms and therefore would have to recognize additional income.

* If a loan structure is not consistently followed or if a taxpayer chooses a nonloan structure, an employee must include the economic benefit in income and report that income under Sec. 83 on all employer-generated cash values that vest to the employee. The notice provides a new table replacing the P.S. 58 costs for computing this benefit.

* If an employer pays a premium without a reasonable expectation of receiving repayment, the entire premium would be treated as compensation to the employee.

The "Background" section of the notice discusses IRS...