Challenge, accomplishment, and success are all important motivators for executives, professionals, and business owners. In addition, these individuals expect to receive financial rewards for their efforts.

While tax reform has severely restricted how highly-compensated individuals may be rewarded, one "perk" that has survived is split-dollar life insurance. With this arrangement, policy premiums, ownership rights, and death benefit proceeds are split between a company and an insured employee.

Benefits Now . . .

Many investors make systematic investing an integral part of their overall savings plan. One very popular and single investment technique is dollar cost averaging. You invest the same amount of money each month (or other interval) whether shares are going up or down in price. Over time, you may achieve a lower average cost per share compared to the share price for a lump sum investment, and you will establish a disciplined approach to investing. Dollar cost averaging does not assure a profit or protect against loss in a declining market. Systematic investment plans involve continuous investment in securities despite fluctuating prices. Therefore, you should consider your financial ability to you continue purchasing shares through periods of low price levels. Securities investments do not offer guaranteed returns and are not federally insured. Therefore, the value of your principal investment will fluctuate due to market conditions, so that your shares, when sold, may be worth more or less than their original cost.

Split-dollar insurance plans are attractive to employers because they allow executives to be selectively rewarded through a “nonqualified” plan—that is, one that does not require Internal Revenue Service (IRS) approval. The selected employees benefit because they are able to acquire more life insurance protection than they might otherwise purchase on their own. The policy is also portable and can be taken with an employee if he or she leaves the company.

Split-dollar plans allow for a number of different methods to pay the policy premiums. One of the more common methods is for the employee to pay a portion of the annual premium while the employer pays the balance. The premium paid by the employer should be structured as a nondeductible business expense.

When the employee pays part of the premium, the employer can eliminate any out-of-pocket expense to the employee by “bonusing out” the employee's cost (“single bonus”) or the cost plus the tax on the cost ("double bonus"). Under either arrangement, the employer receives a tax deduction for the bonus payments as compensation paid, provided the employee's overall compensation qualifies as "reasonable" according to IRS guidelines. By using the split-dollar method, the company can also include its share of the policy's cash surrender value on its balance sheet.

. . . and in the Future

Upon either the employee's death or the policy’s termination, the firm is assured a return of the greater of its aggregate premium contribution or the policy’s cash surrender value, according to the plan agreement.

The insured employee usually has the right to designate the beneficiary for the portion of the death proceeds that are not payable to the employer. However, the employee's possession of this right is considered an "incidence of ownership" and will, thus, cause the beneficiary's portion of the proceeds to be included in the employee's gross estate. Employees may assign this ownership right to avoid inclusion of the proceeds in their gross estates for federal estate tax purposes. However, if an employee does not survive for three years from the date of the assignment, the proceeds revert to the estate.

In the case of a sole shareholder or an employee who is a majority shareholder, care must be exercised in setting up the split-dollar plan due to greater restrictions on assignments of interests and transfers of ownership. However, for employees who are not shareholders, split-dollar insurance can be protected from estate taxes by establishing third-party ownership at the outset, thereby avoiding a future transfer of ownership. The third-party owner is frequently an irrevocable life insurance trust.

Upon termination of a split-dollar plan, the owner may keep the policy in force or surrender it. The contract may be "rolled out" to the employee. The employee may continue the payments or take the policy on a paid-up basis.

Split-dollar insurance can be an important part of any business’s benefit planning package. However, it is essential that you review all the available options to ensure they are consistent with your overall goals and objectives. Your financial representative can help you determine if a split-dollar life insurance plan can benefit you, your company, and your employees.

Copyright © 2002 Liberty Publishing, Inc. All rights reserved.

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  Split-Dollar For S Corporations

Although split dollar life insurance arrangements have merit as a supplemental benefit for many business owners and key executives, they are generally not viewed as a practical option for S corporations. This is due to the “pass-through” nature of taxation in an S corporation, under which premiums paid by the corporation are included in the insured’s income to the extent of the insured’s ownership of S corporation stock. (The value of the economic benefit (VEB) is also included in income if the plan is noncontributory.) However, when business success may lead to a substantial estate tax bill, owner-employees of S corporations may benefit from the use of split dollar life insurance as a creative estate planning strategy to help minimize taxable gifting.

Traditional Split Dollar

Under a traditional split dollar arrangement, a life insurance policy is purchased on the life of a business owner or key executive. Typically, the insured owns the policy and assigns a portion of the death benefit to the corporation to cover the corporation’s total premium outlay over the life of the policy. A large part of the annual premium is paid by the corporation. The insured is responsible for paying only the portion of the premium equal to the economic benefit of the death proceeds to be received (as determined by the Internal Revenue Service Table P.S. 2001 or the insurer’s lowest published one-year term rate). In other words, the insured is paying term insurance rates.

Creative Use for S Corporations

At first glance, due to the pass-through nature of taxation of corporate-paid premiums in an S corporation, a split dollar arrangement may appear to have little benefit to the insured. However, if the owner faces a potential estate tax problem, using an irrevocable life insurance trust (ILIT) as a third-party owner under a split dollar arrangement can help minimize taxable gifting to the trust.

With this planning alternative, the split dollar arrangement is made between the S corporation and the ILIT, rather than the S corporation and the owner (with a restricted majority shareholder collateral assignment to the S corporation). The ILIT beneficiaries are usually the insured’s children or grandchildren and ILITs are typically funded with gifts made by the insured (the donor). Gifts are made using the donor’s annual gift tax exclusion ($11,000 per person per donee for 2002). Because, in the case of a split dollar arrangement, the ILIT pays only a portion of the premium equal to the one-year term cost, it is possible to minimize gift taxation for the donor and, in addition, have the corporation fund a portion of the ILIT.

Even in an S corporation, where premiums paid by the corporation are included in the insured-owner’s taxable income (to the extent of the insured’s stock ownership), using a split dollar arrangement can create gifting advantages that may potentially outweigh the purchase of life insurance (either by the insured or an ILIT) independent of any agreement with the corporation. (Again, the VEB may also be included in income if the plan is noncontributory.) By taking advantage of the opportunities offered under the split dollar arrangement, the insured will pay a reduced portion of the premium (the economic benefit), thus enabling the insured to potentially minimize gift taxation.

A Valuable Estate Planning Technique

Contrary to what some may think, split dollar life insurance may offer benefits to S corporations. When used as a mechanism to help fund a business owner’s ILIT, a split dollar arrangement can be an attractive estate planning technique. However, as with all advanced planning issues, it is essential that the potential tax consequences be reviewed before implementing this strategy.

Copyright © 2002 Liberty Publishing, Inc. All rights reserved.

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  Split Dollar Means Sharing Benefits

The mobility—some might call it “leapfrogging”--of employees from company to company can be especially hard on today's small business owners. Split dollar insurance allows employers to offer your key executives life insurance as a fringe benefit with the goal of increasing their loyalty to the business.

Split dollar is not a type of policy; rather it is a way to share the costs and benefits of a single insurance policy. "Split" refers to the sharing of premiums, cash value, and death benefits of a life insurance policy funded by an employer and owned by an employee.

Because split dollar arrangements are nonqualified plans—not subject to Internal Revenue Code (IRC) pension regulations—you can offer them to whomever you choose without increasing your paperwork burden. But, since split dollar plans can be designed with a variety of cost recovery options for the employer, the standard caveat applies: Consult your tax and insurance professionals before signing on the dotted line. The ongoing debate among tax and insurance professionals about the IRS’ interest in the employee’s equity in the policy suggests you exercise even greater diligence in understanding the tax impact of this type of arrangement.

Thanks for Sharing

Split dollar plans benefit both the selected employees and the employer. Your key executives and your accountant may thank you for setting up such a plan for the following reasons.

Employees can get a substantial amount of life insurance for less than if they paid for it from their personal after-tax income. Additionally, in the event of the employee's death, the beneficiary receives the death benefit (some of which may go to the employer to cover the cost of premiums paid) income tax free.

Employers, having sprung for a split dollar arrangement to help attract and retain top-level executives, can recover the amount of premiums through cash values or death benefits at the time of the employee’s death or retirement. These amounts are received tax free by the employer. Keep in mind, however, that premium payments themselves are not an allowable income tax deduction, although a small portion of the premiums’ cost will usually be contributed by the employee to avoid paying income tax for the life insurance protection.

In fact, split dollar arrangements are often cited as one of the few fringe benefit plans under which most or all of the employer’s costs are recovered.

Put It in Writing

Split dollar arrangements involve three parties: employer, employee, and beneficiary. The employer and employee agree upon what portion of the death benefit or cash value will go to the employer to repay the premium costs. Any balance then goes to the employee or beneficiary, usually a spouse, child, or trust.

One arrangement stipulates that the policy owner signs a collateral assignment and promissory notes, in effect borrowing the premium amounts from the employer. Another arrangement involves the employer owning and paying for the policy, with the employee paying an agreed-upon portion of the premium to the employer.The different types of arrangements are, in some cases, a reaction to the IRS debate mentioned earlier concerning whether the excess of the cash value over the premiums paid represents the employee's equity in the policy and whether the excess is taxable income.

Clearly, the longer the employee stays with you, the greater his or her share of the split plan arrangement. This type of insurance plan rewards employee longevity, worth cultivating among today's up and coming executives.

Copyright © 2002 Liberty Publishing, Inc. All rights reserved.

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