Sterling Plan yields tarnished tax results.

• Author: Beavers, James A.

In consolidated test cases involving the Sterling Plan, a purported welfare benefit plan, the Tax Court held that life insurance policies issued on the lives of employees of C corporations and S corporations as part of the corporations' participation in the Sterling Plan were part of a split-dollar life insurance arrangement; thus, the employees realized income for the benefits they received from the life insurance policies, and the corporations could not deduct the payments made to the welfare benefit plan.

Background

Almost 50 cases were filed in the Tax Court regarding deficiencies assessed by the IRS stemming from the various taxpayers' participation in the Sterling Plan. The IRS and the taxpayers selected seven cases as test cases to resolve the issues related to the Plan and agreed to be bound by the results in the test cases. Five of these cases involved the purchase of insurance for employees of a C corporation or an S corporation by the Plan to fund the retirement benefits it offered. (Two of the cases, not discussed below, involved a corporation that participated in the Plan but did not purchase insurance for employees through it.)

The Sterling Plan was marketed as a welfare benefit plan consisting of the respective separate plans that each participating employer customized to apply to its employees alone. The Sterling Plan would pay death, medical, and disability benefits with respect to a participating employee to the extent that his or her participating employer selected. Each employer selected the general provisions, the participation requirements, and the vesting schedule applicable to its Plan. Each employee designated to whom the Plan would pay the benefits with respect to the employee.

The death benefit that the Sterling Plan agreed to pay to a participating employee was the face amount of an insurance policy that it purchased on the employee's life. The employer effectively paid the premiums on the insurance policy through its payments to the Plan, and the insurance policy usually had a cash-value component that increased annually. The Plan's payment of any nondeath benefit to an employee was generally limited to the cash value of the insurance policy related to that employee. An employer could terminate its participation in the Plan and cause each of its employees to be fully vested in his or her policy (including its cash value). A participating employee, upon retiring, could take his or her insurance policy in satisfaction of any post-retirement death benefit payable to the employee.

The life insurance purchased for the corporations' employees was purchased by the Sterling Plan, but the employees were required to make formal applications for the insurance, answering standard...