Greenberg Traurig Alert
New IRS Guidance for Taxation of Equity Split Dollar Arrangement
By Jeffrey D. Mamorsky, Greenberg Traurig,
New York Office*
* Appreciation is extended to my partner, Steven B.
Lapidus, and Lawrence L.
Bell, J.D., L.T.M., Counsel for Advanced Markets, The BISYS Group, for
assistance in the preparation of this Alert
View or download the PDF version of this Alert here.
The IRS, in Notice 2001-10 (IRB 2005, 1/29/01), has announced a
change in the tax rules that have governed the executive
compensation tool known as split dollar life insurance since 1964.
These changes are in the form of "interim guidance"
without any meaningful grandfathering protection. The Notice states
that it is (i) intended to "clarify" prior rulings issued
by the IRS regarding the taxation of split-dollar arrangements; and
(ii) provide taxpayers with interim guidance on the tax treatment of
split-dollar arrangements "pending publication of further
|"The IRS... has announced a
change in the tax rules that have governed the executive
compensation tool known as split dollar life insurance..."
Proposed Clarification of Prior Rulings
At the outset, the IRS emphasized that the rules which have
governed the taxation of split-dollar arrangements since 1964
involve a form of contractual agreement between the employer and
employee to "join in the purchase of a life insurance
contract" in which the premiums and the policy benefits are
allocated between the employer and the employee (Rev. Rul. 64-328,
1964-2 C.B. 11, and Rev. Rul. 66-110, 1966-1 C.B. 12). According to
the IRS, under these rulings "all amounts credited to the cash
surrender value of the life insurance contract inured to the benefit
of the employer" in exchange for its premium payments.
The only economic benefit inuring to the employee was the value
of current life insurance protection, which is taxed to the employee
in accordance with the P.S. 58 Table contained in Rev. Rul. 55-747
(1955-2 C.B. 228) to the extent that it exceeds the employee’s
share (if any) of the premium payments.
According to the IRS, although the rulings described two
contractual methods — the endorsement method (under which the
employer is formally designated as the owner of the contract), and
the collateral assignment method (under which the employee is
formally designated as the owner of the contract) – "the
determination of an employee’s gross income is unaffected by
***[which]*** method is used." In either case , the IRS Notice
emphasized that the rulings conclude that "all economic
benefits conferred on an employee under such an arrangement,
excluding economic benefits attributable to the employee’s own
premium payments, constitute gross income to the employee."
In Notice 2001-10, the IRS expressed the view that none of these
rulings addressed "equity split-dollar," the most common
split-dollar arrangement involving a shared ownership of a life
insurance contract by an employer and its employee under which the
employer’s interest in the cash surrender value of the contract is
limited to the aggregate amount of its premium payments, exclusive
of any cash value over employer premium outlays ("excess cash
The problem with this position is that since 1964 the IRS has
taxed the employee each year solely on the value of the
insurance protection provided under the policy in excess of the
amount paid by the insured. Specifically, in Rev. Rul. 64-328, the
IRS concluded that (i) the measure of the income taxable to the
employee under a split-dollar arrangement is the cost of the death
benefit protection, equal to the one year term cost of the life
insurance coverage to which the employee is entitled from year to
year and (ii) the one year term cost is measured as the so-called
P.S. 58 cost, referenced in Rev. Rul. 55-713, 1955-2 C.B. 23. Rev.
Rul. 66-110 expanded the available sources to be used for
determining this annual taxable term insurance cost, permitting
employees to utilize the current published term rates charged by
the insurer with which the policy is placed for life insurance
available to all standards of risks, if these insurer rates are
lower than the P.S. 58 cost.
At no point in the text of Rev. Rul. 64-328 did the IRS suggest
that, in addition to the term insurance costs, all or a portion of a
split dollar policy’s cash surrender value also should be taxed to
the employee. The IRS’ new position enunciated in Notice 2001-10
is that the ruling did not address an equity split dollar
arrangement where the cash surrender value in excess of the
repayment obligation to the employer would remain with the employee.
However, such a position ignores the explicit language of Rev. Rul.
64-328 which suggests that the IRS did indeed consider equity split
dollar arrangements in reaching its conclusion:
"[t]he Employer is entitled to receive, out of the
proceeds of the policy, an amount equal to the cash surrender
value, or at least a sufficient part thereof to equal the funds
it has provided for premium payments." (Emphasis added.)
Moreover, in Rev. Rul 66-110 the IRS addressed whether the value
of the "other benefits" provided pursuant to a split
dollar life insurance arrangement, in addition to the annual cost of
the life insurance protection, also had to be included in an
employee’s taxable income in the year accrued. The ruling
concluded that certain "other benefits" should be
included; however, it provided as examples of "other
benefits" dividends and additional life insurance. The ruling
did not include as an "other benefit" the annual accrual
of excess cash value to which the employee ultimately may be
entitled. This implicitly confirmed in many practitioners’ minds
that the IRS shared their view that the employee should not be taxed
on excess cash surrender value. Rev. Rul. 78-420, 1978-2C. B. 67,
which significantly was issued after the statutory enactment of
Section 83 of the Internal Revenue Code of 1986, as amended (the
"Code"), further confirmed this conclusion.
IRS Notice 2001-10 discards as inapplicable to equity
split-dollar the traditional theories of Rev. Ruls. 64-328 and
66-110 and sets forth two new alternative theories of taxation, one
of which – the "Section 83" analysis – closely mirrors
the IRS position in Technical Advice Memorandum (TAM) 9604001.
In TAM 9604001, the IRS found that Code Section 83 is applicable
to an equity split dollar life insurance arrangement between the
employer and employee. However, the TAM is vague as to the manner in
which Code Section 83 should be applied to such arrangements.
According to the TAM, not only is the value of employer-provided
current annual life insurance protection includible as taxable
compensation to the insured employee each year, but, in addition,
the employee equity portion of the policy’s cash surrender value
also is taxable to the employee under the principles of Code Section
In IRS’ "interim" guidance set forth in Notice
2001-10, the taxpayer is offered a choice, "pending
consideration of public comments and publication of further
guidance," of treating the equity split-dollar arrangement
either as a loan, taxable under Code Section 7872, or as a transfer
of property (cash value build-up) under Code Section 83. In general,
the parties’ characterization under either option will be followed
- the characterization is not clearly inconsistent with the
substance of the arrangement;
- the characterization has been consistently followed by the
parties from the inception of the arrangement; and
- the parties fully account for all economic benefits conferred
on the employee in a manner consistent with the
As a loan, the arrangement would be taxable under Code Section
7872 which recharacterizes an interest-free or below-market interest
rate loan (which may be a "term" loan or a
"demand" loan) as an arm’s length transaction involving
an imputed payment from the lender (in this case the employer) to
the borrower (in this case the employee) in an amount equal to the
difference between the stated interest rate and a statutory interest
rate (the "applicable federal rate", or "AFR"),
and a corresponding payment of imputed interest from the borrower to
the lender in the same amount. In the case of a compensation-related
below-market loan, the imputed payments to the borrower are treated
as compensation income.
According to IRS Notice 2001-10, in any case in which an employer’s
payments under a split-dollar arrangement have not been consistently
treated as loans, the parties will be treated as having adopted a
non-loan characterization of the arrangement, and the parties must
"fully account for all the economic benefits that the employee
derives from the arrangement in a manner consistent with that
characterization and with Rev. Rul. 64-328, Rev. Rul. 66-110, and
the general tax principles upon which those rulings are based."
According to IRS, this means that (i) the employer will be
treated as having acquired beneficial ownership of the life
insurance contract through its share of the premium payments, (ii)
the employee will have compensation income under Code Section 61
equal to the value of the life insurance protection provided to the
employee each year that the arrangement remains in effect, reduced
by any payments made by the employees for such life insurance
protection, (iii) the employee will have compensation income under
Code Section 61 equal to any dividends or similar distributions made
to the employee under the life insurance contract, and (iv) the
employee will have compensation income under Code Section 83(a) to
the extent that the employee acquires a substantially vested
interest in the cash surrender value of the life insurance contract,
reduced under Code Section 83(a)(2) by any consideration paid by the
employee for such interest in the cash surrender value.
Code Section 83(a), provides, that if "property" is
"transferred" to any person in connection with the
performance of services, the excess of the fair market value of such
property over any amount paid therefor will be included in the gross
income of the person who performed such services in the first
taxable year in which the recipient becomes "vested" in
the property (i.e., in the first taxable year in which the rights of
the person having the beneficial interest in the transferred
property are transferable or are not subject to a substantial risk
Importantly, the Notice states that, "pending the
publication of further guidance," the employer will not be
treated as having made a transfer of the cash surrender value of the
policy simply because the cash surrender value exceeds the premiums
advanced by the employer. "If future guidance provides that
such earnings increments are to be treated as transfers of property
for purposes of Section 83, it will apply prospectively."
IRS’ assertion of the application of Section 83 under
subparagraph (iv) above is unclear. Although the Notice does not
directly reference "roll-outs" (where the employer at
termination of employment or at some other time
"rolls-out" of the policy an amount equal to the amount of
the premiums advanced and relinquishes all other rights under the
policy including any rights to the excess cash surrender value, the
IRS has informally indicated that the reference to Section 83 in
subparagraph (iv) would require income recognition at the time of
the roll-out in an amount equal to the excess cash surrender value.
Structuring a split dollar arrangement so that there is no roll-out,
but rather the arrangement continues in effect until the employee’s
death and the employer is reimbursed for its premiums out of the
death benefit proceeds, may be the answer to this dilemma.
Revocation of P.S. 58 Rates
Notice 2001-10 replaces the P.S. 58 rates with rates in new Table
2001 for valuing death benefits under split dollar arrangements and
qualified plans. Specifically, pending the consideration of comments
and publication of further guidance, the following interim guidance
- Rev. Rul. 55-747, and the P.S. 58 Table contained therein, is
revoked. However, taxpayers may continue to use the P.S. 58
rates for taxable years ending on or before December 31, 2001.
- A New Table 2001 may be used to determine the value of current
life insurance protection on a single life provided under a
split-dollar arrangement or qualified retirement plan for
taxable years ending after the date of issuance of the Notice.
Table 2001 is based on the mortality experience reflected in
Table 1 under Code Section 79, with extensions for ages below 25
and above 70, and the elimination of the five-year age brackets.
These rates are materially lower than the P.S. 58 rates at all
- Taxpayers may continue to determine the value of current life
insurance protection by using the insurers’ lower published
premium rates that are available to all standard risks for
initial issue one-year term insurance as set forth in Rev. Rul.
66-110. However, for periods after December 31, 2003, the IRS
will not consider an insurer’s published premium rates to be
available to all standard risks who apply for term insurance
unless the following requirements are met:
- The insurer must make the availability of such rates known
to persons who apply for term insurance coverage from the
- The insurer must regularly sell term insurance at such
- The insurer must not more commonly sell term insurance at
higher premium rates to individuals that the insurer
commonly classifies as standard risks.
What to Do
In view of IRS Notice 2001-10, it is important that care be taken
in the structure of split dollar life insurance programs. The Notice
does not provide for any meaningful granfathering. Accordingly,
every split dollar arrangement should be reviewed to determine the
potential impact of the Notice upon the arrangement. In particular,
consideration needs to be given to the amount of income that must be
recognized each year by the employee based upon the economic benefit
he receives as measured in accordance with the Notice, potential
ways of avoiding that income recognition through premium payments by
the employer or other co-owner of the policy, minimizing the gift
tax consequences resulting from that economic benefit (or from the
premium payments made to avoid income taxation therefrom), and
addressing the potential income tax consequences at the time of the
roll-out. Also, the Notice states that use of the "safeharbor"
approaches discussed above (loan or Section 83 treatment) must be
used from the inception of the arrangement in order to avoid the
negative tax implications of the Notice.
The firm’s executive compensation and employee benefits group
can help you structure a program to minimize the potential impact of
IRS Notice 2001-10 as well as accomplish other income and estate tax
goals for your executive workforce.
© 2001 Greenberg Traurig
For more information, please review our Executive
Compensation & Employee Benefits Group description, or feel free to contact one of our attorneys.
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