US Treasury Will End Tax-Efficient Insurance Schemes

by Mike Godfrey, Tax-News.com, New York

05 July 2002

As expected, the US Treasury Department yesterday proposed rules that would tax executives for life-insurance policies widely used in compensation packages for top managers. The so-called split-dollar arrangements, in which companies pay the bulk of premiums on life-insurance policies that benefit executives or their families, would lose their current tax advantages.

Said the treasury:

'Today, the Treasury Department and the IRS issued proposed regulations on the tax treatment of split-dollar life insurance arrangements. These regulations provide comprehensive rules on split-dollar life insurance, resolving many questions about how these arrangements are taxed.

'A split-dollar life insurance arrangement involves two parties agreeing to split the premiums and/or benefits of a life insurance policy. These arrangements are often used as a type of employee compensation or for making gifts among family members. The tax treatment of split-dollar life insurance has been unclear for many years.

'The proposed regulations require a split-dollar life insurance arrangement to be taxed under one of two sets of rules—depending on who the owner of the policy is. If the employee is the owner of the policy, then the employer’s payments of premiums are treated as loans to the employee. Consequently, unless the employee is required to pay the employer market-rate interest on the loan, the employee will be taxed on the difference between the market-rate interest and the actual interest.

'If the employer is the owner, the employer’s payments of premiums are treated as the employer providing "economic benefits" to the employee. The economic benefits would include the value of the life insurance protection provided together with any other benefits provided the employee under the arrangement.

'As indicated in Notice 2002-8, the proposed regulations will apply only to split-dollar life insurance arrangements that are entered into after the date the regulations are published in final form. Until then, taxpayers may rely on the proposed regulations.'

These new rules were originally proposed under the previous administration, although they won't be retrospective, unlike the Clinton-era proposals. Reaction from the insurance industry to the grandfathering of existing arrangements was very positive, and companies have at least until October 23 to enter new arrangements under the existing rules.

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