IRS taxes cash surrender value of split-dollar life policy placed in trust for benefit of executive.

• Author: Vines, Joan H.

Until now, the IRS has not ruled on the more customary split-dollar plan in which an employer's interest is limited to its aggregate premium outlay and the remaining cash surrender value is payable to the employee. In Letter Ruling (TAM) 9604001, in which the life insurance policies were in trust, the Service concluded that the employee was taxed on the total economic value of the split-dollar life policy. The economic value equals not only the PS 58 cost (or actual premium, if less) of the death benefit, but also the cash surrender value that accumulates inside the policies in the trust. The cash surrender value is considered property under Sec. 83 and taxable to the employee when transferred or set aside from the claims of general creditors.

The cash surrender value (i.e., property for Sec. 83 purposes) of split-dollar arrangements not"transferred or set aside" from the claims of general creditors would not be taxable to the employee until received (pursuant to Sec. 61).

Rev. Rul. 64-328 described a typical split-dollar arrangement used in the 1960s and 1970s: an employer and employee join in purchasing an insurance contract, in which there was a substantial investment element, on the life of the employee. Generally, the employer provided the funds to pay part of the annual premium (to the extent of the increase in the cash surrender value each year), and the employee paid the balance. The employer was entitled to receive, from policy proceeds, an amount equal to the cash surrender value, or at least a part thereof sufficient to equal the funds it had provided for premium payments. The employee had the right to name the beneficiary of the balance of any proceeds payable by reason of the employee's death. Although the employee had to pay a substantial part of the first premium, after the first year the employee's share of the premium decreased rapidly, and in some cases it even became zero after a relatively few years. The employee thus obtained valuable insurance protection with a relatively small outlay of premium in the early years, and at little or no cost in later years. The effect of the arrangement was that the earnings on the investment element, which at arm's length would go to the employer, were applied to provide current life insurance protection to the employee at either no cost to the employee or at a cost less than the employee would pay absent the arrangement. The ruling concluded that the employee received an economic...