Split-dollar life insurance alert!(tax changes under Sarbanes-Oxley Act of 2002)

• Author: Whitlock, Brian T.

Split-dollar life insurance arrangements have been excellent vehicles for small and large corporations. Small corporations have frequently paid a portion of the premiums for shareholders and, thus, helped them to leverage gifts. Large corporations have used split-dollar arrangements to provide key employees with nonqualified deferred compensation benefits in excess of the qualified plan limits.

Two major changes--one legislative and the other regulatory--propose to change the use of split-dollar arrangements. First, under Section 402 of the Sarbanes-Oxley Act of 2002 (SOA), public companies are prohibited from making (directly or indirectly) extensions of credit in the form of personal loans to their officers and directors. This will likely eliminate the use of split-dollar life insurance arrangements for such companies' key employees.

Second, proposed regulations (REG-164754-01) govern the future Federal income, employment and gift tax implications of split-dollar arrangements. The proposed regulations reverse over 35 years of tax history; however, unlike the SOA, the IRS will allow small businesses to continue to use all split-dollar arrangements. Although caution is warranted, the proposed regulations also allow existing split-dollar plans to make an election that could save future taxes. Tax advisers should review client split-dollar arrangements to determine if their clients could benefit by making the election before 2004.

Background

A split-dollar insurance arrangement is defined by Prop. Regs. Sec. 1.61-22(b) (1) as "any arrangement" (not part of a Sec. 79 group term life insurance plan)"between an owner of a life insurance contract and a non-owner of the contract under which either party to the arrangement pays all or part of the premiums, and one of the parties paying the premiums is entitled to recover (either conditionally or unconditionally) all or any portion of those premiums and such recovery is to be made from, or is secured by, the proceeds of the contract"

The typical split-dollar arrangement occurs between an employer and an employee. The most common type is collateral-assignment split dollar, in which the insured (or an irrevocable trust for his or her family's benefit) owns the policy, while the insured's employer pays some or all of the premiums. On the insured's death, the employer is repaid its premiums; the beneficiary receives the balance of the proceeds. Under current law, the insured employee is only taxed...