Notice 2001-10 applies to existing split dollar arrangements and should not be disregarded merely because it provides "interim" guidance on the taxation of such plans. It is not a matter of "if" the IRS will provide final guidance in the future, it’s just a matter of when. Existing plans should be evaluated to determine the tax effect of the notice to the insured, and to decide whether to leave the plan as is, or to restructure or prematurely roll out the plan if necessary.
Traditional Split Dollar
Traditional split dollar arrangements, where the employer is entitled to receive the entire policy cash value, will generally be less attractive. The employee’s taxable benefit in this arrangement is deemed to be the value of the term insurance portion of the premium. Generally, the new Table 2001 rates will be higher than the insurer-specific rates that are widely used today to measure the term value, so employees will report more taxable income for the employer-funded death benefit. However, plans using the old P.S. 58 rate table may benefit because the Table 2001 rates are lower than the rates in the outdated P.S. 58 table. Traditional split dollar plans should be reviewed to determine whether it is tax-efficient to maintain them.
Equity Split Dollar
Under final guidance, transfers of equity buildup in endorsement plans (where the employer owns the insurance policy and endorses the right to the death benefit and excess cash value to the employee) will almost certainly result in compensation income to the employee, whether at rollout or during the arrangement. Consequently, it may make sense to restructure such a plan or even roll it out before final guidance is issued to minimize taxable compensation to the employee. Endorsement method equity split-dollar arrangements may not make tax or economic sense anymore, and could consequently fall by the wayside.
Collateral Assignment Plan:
It is more difficult for the IRS to characterize a collateral assignment plan as a taxable transfer from the employer to the employee. Under such plans, the employee owns the insurance policy and assigns the policy as collateral to the employer in return for employer-paid premiums. These plans are, economically, an interest-free loan from employer to employee. Notice 2001-10 promised that the IRS will respect taxpayers’ consistent characterization of split-dollar arrangements as either interest-free loans or taxable property transfers. The Service did not say what it will do about existing split-dollar agreements that have not consistently taken a loan or taxable transfer position. Some practitioners believe that future guidance will grandfather existing collateral assignment plans as a taxable interest-free loan to the employee under Section 7872 rather than as a compensatory transfer of property under Section 83. This may lead to a "wait and see" approach before restructuring such plans. For plans established in the future, taxpayers who find it worthwhile to use split-dollar agreements will need to carefully structure and implement them to obtain the desired treatment as either a loan or a transfer of property.
Collateral Assignment Plan with Irrevocable Life Insurance Trust (ILIT):
In this variation, the employee sets up an ILIT to benefit family members. The ILIT owns the policy and assigns the policy as collateral to the employer, who pays the premiums. The employee recognizes imputed income for the cost of term life insurance, which is also a gift from the employee to the trust. The Notice applies restrictions on using the insurer’s one-year term rates, and replaces them with higher Table 2001 rates, which may increase potential exposure to gift and generation-skipping transfer taxes. Current plans should be reviewed especially in light of the recent estate and gift tax legislation to determine whether such arrangements should be restructured or terminated.
Reverse Split Dollar
In a reverse split dollar plan the employee owns the policy and pays the premiums. The employee then allows the employer to designate itself as beneficiary of part of the death benefit in return for a fee for this right. The fee is based on the P.S. 58 rate death benefit cost thereby reducing the employee paid premiums. By replacing the P.S. 58 rates with the much lower Table 2001 rates, more of the company paid premium will likely be taxable compensation income to the employee, eliminating the main attraction of such arrangements.