Letter ruling on split-dollar insurance requires caution for S corporations.

• Author: Robbins, Andrew J.

A second class of stock is fatal for an S corporation. The second class of stock does not always have to be apparent or intended. IRS Letter Ruling 9318007 considered whether a split-dollar insurance arrangement created a second class of stock (within the meaning of Sec. 1361(b)(1)(D)). The Service looked to whether the arrangement altered rights to distribution and liquidation proceeds that would create a second class of stock (under Regs. Sec. 1.1361-1(1)(1)).

Background

Many employers offer financial assistance to key employees that enables them to purchase life insurance, by entering into arrangements in which the employers advance the amount necessary to pay all or part of the annual premium in exchange for the employee's obligation to repay the advances out of the policy proceeds. This arrangement generally is referred to as split-dollar insurance. Very often, the arrangement involves an irrevocable life insurance trust.

Rev. Rul. 64-328 held that, when there is a split-dollar arrangement, the value of the insurance provided by the employer that exceeds the portion of the premiums paid by the employee must be included in the employee's gross income. The economic value of the insurance is derived from the "P.S. 58" rates (based on U.S. Life Table 38) and is the amount the employee must include in gross income if not repaid to the employer. This revenue ruling, the cornerstone of all split-dollar arrangements, dealt with an employer-employee situation.

Rev. Rul. 79-50 described the income tax consequences of a split-dollar arrangement entered into between a corporation and a shareholder. Rev. Rul. 79-50 stated that the arrangement between a corporation and a shareholder is similar to the type contemplated by Rev. Rul. 64-328. The key difference is that, if the shareholder is not obligated to reimburse the corporation, the economic benefit derived by the shareholder is a distribution with respect to the corporation's stock and must be treated in accordance with Sec. 301 (c).

The split-dollar arrangement in Letter Ruling 9318007 was similar to the arrangement described in Rev. Rul. 79-50 except that it required reimbursement by the shareholder or by an irrevocable trust...